ESOP 101: Communicating and Administering an ESOP – Part 4
By Joanne Hue, published: 2023-04-04
ESOP stands for an Employee Stock Option Plan and it provides the employees of a company the option to hold shares in the company they are working for. An option plan provides benefits to both the employee and the sponsoring company in form of tax benefits.
ESOP is a cost-effective method to align the interests of the company’s employees with that of the company’s shareholders. As the workers hold the right to exercise their options and eventually acquire proportional ownership in the company, ESOP is an efficient method of incentivizing the productivity of employees. This allows the company to sustain and reward competent workers.
If your enterprise intends to set a share option plan for its employees, you need to be aware of methods of communicating and administering ESOP. Moreover, you cannot presume that all employees will understand the scheme. Effective communication with your employees is crucial to setting a successful share option plan.
Communicating an ESOP
A Share Option Scheme is essentially an equity-based compensation for employees. It can bear intricacies that are not readily understandable to the employees. Therefore, prior to setting a share option plan, the company should ensure its employees understand its proceeding, benefits and outcomes. Simply put, communication with your intended participants is vital to the success of your scheme.
Large corporations tend to separate a considerable amount from their budget for the sole purpose of efficient communication. This indicates that businesses understand the value of communication in the efficiency of the set option plan. Your employees need to understand that any equity compensation including an ESOP is directly related to financial elements. This includes profitability, business cycles, profitability, balance sheets, ratio and the stock market. An option holder may not always understand these elements. Your employees need to be familiarized with the risks associated with purchasing a share.
An ESOP is a long-term instrument to increase employee productivity and align the interests of the employee with the shareholders. Participating in options that provide employees with the opportunity to access ownership in the company also means that the employees need to be aware of the status of the company. If they are unaware of the status of the company, they may either miss out on it or unwisely spend their hard-earned money on purchasing stocks.
The company is responsible for communicating any business devaluation or deferment of value appreciation caused by the macro and micro economic fluctuation in the vesting period. Communicating ESOP and these trends effectively is necessary to make option holders understand that valuation is subject to external factors.
Providing equity in the company means that you are essentially allowing your employees to prospect to be a partner in your business. It is crucial for your option holders to feel like their stakes lie in the company. This is a motivational factor for the option holders.
If you intend to improve communication with your business’ option holders, you can use various methods to communicate with them. Usually, companies use meetings, handbooks, FAQs, fliers, banners or emails to inform the option holders about important issues like the lapse of option, vesting alerts, and termination of the exercise period. Companies also need to provide their employees with details about the latest independent valuation of the options.
Addressing the expectations of the shareholders is also an important part of maintaining communication. For instance, when the company is raising capital rounds, option holders may assume that exercising their rights to sell the shares would gardener profit. It is the business’s duty to address and clarify doubts concerning their expectations.
Corporate action, especially in the nature of Change in Control, often results in a situation where investors get an exit and realize their appreciation, the Option holders are often expected to continue with their Options by the incoming investors. Open and transparent communication apart from fair treatment is extremely essential to uphold the spirit with which Options were given to employees.
Research suggests that a third of options lapse. Sometimes the employee cannot afford the purchase price, or they leave their job causing their option to prematurely expire. Other than that, there is a lack of education and awareness surrounding the Employee Share Option. Companies can avoid its ESOP from lapsing by efficiently communicating their utility with their employees.
Practical suggestions for Administering ESOP and Issue Options
Companies need to pay special attention to some matters while setting up an ESOP or issuing an option. Sometimes, employers may have to provide a disclosure document to their employees. Unless an exemption is applicable, a document of disclosure is always applicable. These exemptions from disclosures may be professional or sophisticated investor exemptions, small-scale offering exemptions, or senior management exemptions.
The distribution of ESOP is decided by the company. However, you need to take certain factors into account prior to making those decisions. The company should consider the total size of the option pool. The role of the employee and their prospective stay in the company should determine the distribution of options.
If your company is seeking to rely on startup tax incentives, you need to ensure that the structure of your ESOP meets the required criteria. Countries like Australia provide tax concessions for ESOPs. Likewise, the UK’s tax provisions offer tax benefits by lowering the tax for employee-owned shares.
Administering an ESOP requires companies to cater to the interests of their employees. This is because setting a share option plan aligns the interests of the employer with that of the company shareholders. Your employees may not always be aware of the intricacies of an ESOP. It is, therefore, the duty of the business to communicate the details concerning vesting, exercise, share valuation, and the termination of terms to their employees. In order to efficiently administer the employee share option, companies need to create a plan that is in line with the tax incentives they are seeking. With exceptions to the cases that allow the exemption, employees should be provided disclosure documents and decide on the distribution of their options.
You may also like:
- ESOP 101: Introduction to Employee Share Option Plans (Part 1 of 10)
- ESOP 101: Understanding Vesting, Exercise, and Expiration Terms Part-2
- ESOP 101: The Process to Set Up an Employee Share Option Scheme Part 3
- What’s an ESOP and why might I need one?
- Employee Share Option Plan Template
- ESOP – Employee Acceptance Letter Template
- How to Set up your company option scheme?