How does Share Vesting work?
If you’re here, you’re likely wondering how share vesting works. In a nutshell, share vesting is the process by which a company gives its equity to its employees or consultants as a means to keep them with the company for a period of time and incentivize them to reach certain established performance goals.
Share vesting is often used when a senior employee or an important advisor or consultant comes on board.
What exactly does share vesting mean?
Share vesting means the company gives its shares to an individual upfront and the shares are subject to the company’s right to buy them back. These shares are known as “unvested shares”. The buyback right extinguishes over time (or upon fulfillment of certain conditions).
The shares that are released from the buyback right are known as “vested shares”. This mechanism is sometimes known as “reverse vesting”, as opposed to the grant of a share option which is “forward vesting” (check out how a Share Option Plan works by clicking here).
Share vesting enables a senior employee or an important advisor to have equity immediately upon coming on board, but the company still retains control over those shares by way of a right to buy back and, in this way, the company keeps the employee or advisor on board until the end of the vesting period. This is how share vesting works.
How Share Vesting works
Step 1: Check your company’s Articles of Association/Constitution
Check if the constitutional document of the company restricts the buyback of its own shares. If it does, you may build in some appropriate mechanisms in your Share Vesting Agreement, or you may consider another form of rewarding your team (for example a Share Option Plan).
Step 2: Create a Share Vesting Agreement
Create and sign the Share Vesting Agreement. After signing, the following will take place:
The employee/consultant pays for the shares on the “Purchase Date” that you set in the agreement;
On the Purchase Date, the company secretary issues share certificates in the name of the employee/consultant and he then becomes a shareholder of the company. The numbers of the share certificates and the number of shares covered by each certificate should match the vesting schedule;
The employee/consultant signs a document known as a “Share Power” and delivers this document to the company secretary;
The company secretary keeps the share certificates in the name of the employee/consultant and the Share Power in escrow; and
When shares are vested (i.e. released from the company’s right to buy back) according to the terms of the Share Vesting Agreement, the share certificate in respect of that part of the shares will be delivered by the company secretary to the employee/consultant.
What is a Share Power?
A Share Power is a document in which the employee/consultant gives his authorization to transfer his shares to the company. It is only used if and when the company exercises the buyback right (which may or may not happen). Some information in the Share Power has to be left blank and can only be filled in by the company when it exercises the buyback right.
Step 3: The share recipient pays for the shares and signs the Share Power Agreement
The employee/consultant pays for the shares on the “Purchase Date” that you set in the agreement.
In addition, the employee/consultant signs a document known as a “Share Power” and delivers this document to the company secretary.
Step 4: The company secretary issues and holds on to the share certificates
Also on the Purchase Date, the company secretary issues share certificates in the name of the employee/consultant who then becomes a shareholder of the company. The number of share certificates and the number of shares covered by each certificate should match the vesting schedule.
The company secretary keeps the share certificates in the name of the employee/consultant and the Share Power in escrow.
This is how share vesting works. However, there are a few more options available.
Optional: Exercise of the buyback right
If the employee/consultant leaves the company, any unvested shares will be subject to the company’s right to buyback. (Note that the vested shares are not subject to buyback but may be subject to the call option. See Step 4 below.)
The company may exercise its buyback right for three months from the date the employee/consultant leaves the company. The buyback right is deemed to be automatically exercised by the company upon the expiry of the three-month period. This is unless the company notifies the employee/consultant that it does not intend to exercise the buyback right.
If and when the company exercises the buyback right, the company needs to pay the buyback price for the shares (which is the same price that the employee/consultant paid for the shares in the first place) to the employee/consultant. Following this, the company secretary takes the necessary steps to make the transfer effective.
After the buyback, under Hong Kong and Singapore law, those shares will be regarded as canceled. Make sure the company secretary makes the necessary filing with the Companies Registry/ACRA within the applicable statutory timeframe after the share buyback.
Optional: Exercise of the call option
When creating the Share Vesting Agreement, you may opt for a “call option” to be put in place. This call option enables the company to do one of two things:
Buyback all vested shares at fair value; or
Convert all vested shares to non-voting shares (i.e. the employee/consultant, being the holder of the vested shares, can still receive dividends from the company but has no say in the decision-making of the company).
The company may exercise the call option for six months from the date when the employee/consultant leaves the company.
The fair value of the shares is determined by the auditors of the company or an independent firm of accountants.
Now you know how share vesting works. All you need to do is get yourself a share vesting agreement, some solid employees to vest shares to, and you’re good to go.
This article does not constitute legal advice.
The opinions expressed in the column above represent the author’s own.
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FURTHER READING: Vest Shares to an Employee or Consultant