Top 7 Guidelines of Using ESOPs
Considering that you have just started your business in Singapore, it is difficult to compete with other organizations in terms of employee compensation to retain the most talented employees. Therefore, companies employ ESOPs, allowing their employees to have a sense of ownership in the organization, and helping to cultivate employee productivity and satisfaction, leading to increased valuation of company.
It also enables the company to bridge the gap between employee compensation and market competitive rates by including additional pay packages, such as employee stock options. ESOP are especially popular with startups and young companies.
ESOPs as source of Employee Motivation & Effective Business Valuation
As soon as employees feel vested in the company, and that they have a stake in their organization’s valuation, they are more likely to be motivated to put extra effort into their work. This is because they consider their work to directly contribute to business’ profitability which in turn would lead to an increased valuation of their own stock options. Hence, ESOPs are a great way to keep your employees motivated.
Top-Talent Retention
Typically, with a minimum period of 1 year as a cliff and 3-4 years as a vesting period, the company can easily retain its top talent without the stress of losing its best employees to the highest bidding competitors. Moreover, employees granted such options tend to stay longer to be able to fully exercise their options.
What factors should be considered when implementing ESOPs?
ESOPs are a prudent way of keeping your employees motivated through compensation packages while keeping your cash flow well-maintained and business valuation process efficient. However, there are certain considerations that must be taken into account before implementing Employee Stock Option Plans.
Complications in the process
The entire process of setting up ESOPs is a complex one. It can consume a lot of time that could be utilized in other important business functions. Additionally, there are countless regulations that have to be complied with, along with the consideration of other alternatives. The whole process could itself be a huge strain on your tight budget. It is always advisable to hire a professional lawyer for setting up ESOPs.
Fixing the percentage of the equity to be allocated for ESOPs
The proportion of equity that you want to allocate specifically for ESOPs depends largely on your personal preference. Be that as it may, it is prudent to always set a limitation on the quantity of equity you want to grant your employees. Normally, Asian companies define a limit— from 5% to 15%– of their equity to be offered to their employees. Resultantly, this allows every employee to benefit from the option of acquiring the company’s equity between 0.5% to 3% of the total value of the business.
Apprehension of equity shareholding dilution
If a company decides to offer a small portion of its equity to its employees as ESOPs, it is possible that the actual business owner might end up with a lesser share of ownership themselves. There may also be the apprehension of a company’s shares becoming unwanted in the market, making it difficult for businesses to exit or be sold on the market.
However, many Asian companies have avoided such kind of situations by ensuring that a clause with “drag-along” rights is included by the Board of Management when preparing ESOPs agreement. Such a clause would allow the company’s specified shareholders to force others, with minority shareholdings, to sell their stocks whenever a suitable offer is made by a third party.
What would happen if an employee decides to leave a company after having their shares vested?
Generally, a retiring employee loses all the unvested options but is allowed to retain the vested ones for a specific period of time. Necessarily, the ESOPs agreement must have a detailed provision that covers this aspect.
We specialize in providing valuation of employee stock options and various other forms of deferred compensation methods. If you are looking to get a valuation of your stock options, or are confused with the intricate process of ESOP valuation, contact us today.
