Establishing your company option scheme upfront is the ideal way to build loyalty among your initial employees and avoid inconsistency and uncertainty going forward.
An Employee Share Option Plan (ESOP) is a scheme that sets out the framework under which share options go to its employees. It’s a common mechanism to incentivise employees.
What is a share option?
Importantly, a share option is not a share. Instead, it is a right to acquire shares when it is exercised. Share options are usually “vested” over time or upon fulfilling certain conditions (e.g. performance targets). Basically, this means that the option holder becomes able to exercise the right and acquire shares in the company.
Steps to create Employee Share Option Plan
Step 1. Draft an Employee Share Option Plan
The Employee Share Option Plan establishes the general rules under which the board will grant the options.
An ESOP typically sets out the purpose of the plan (e.g. to incentivise employees). Also, who will be eligible to participate in the plan (e.g. employees of all levels or a certain level or above). And, most importantly, the overall size of the pool of shares that the option holders will be able to buy.
The Employee Share Option Plan also generally sets out how to grant an option. And, how to exercise an option granted. As well as what happens when the option holder leaves the company or dies.
Essentially, the Employee Share Option Plan should specify the maximum number of shares they can issue under that plan. The company can change this number later by amending the stock plan with approval of the board and stockholders. The company must reserve the shares for allocation under the plan. And it must have enough shares available for issuance in order to do so. The reserved shares are often collectively referred to as an option pool or stock option pool.
Step 3. Grant employee share options
Basically, following the adoption of the Share Option Plan, the company may now grant options to individuals by issuing Option Certificates. The company must legally to issue an “Option Certificate”, which sets out the terms and conditions of the ESOP.
Additionally, it is also customary for the company to issue a Letter for Grant of Option as a cover letter. This provides more details regarding the procedures to follow for the exercise of the option by the employee.