Share vesting is when a company gives its equity to its employees or consultants to keep them with the company and incentivize them to reach established performance goals.
You will likely find your share options in your Employment Contract, and they are often used when a senior employee or an important advisor or consultant comes on board.
What are vesting shares?
Share vesting means the company gives its shares to an individual upfront, and the shares are subject to the company’s right to repurchase them.
These shares are known as unvested shares. The buyback right extinguishes over time (or upon fulfilment of certain conditions).
Shares released from this 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.
Share vesting enables a senior employee or an advisor to have equity immediately upon coming on board. However, 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.
How share vesting works
Step 1: Check your company’s Articles of Association/Constitution
Check if the company’s constitutional document restricts the buyback of its shares.
If it does, you may build in some appropriate mechanisms in your Share Vesting Agreement or 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 company shareholder. The number 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.
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” you set in the agreement.
In addition, the employee/consultant signs a “Share Power” and delivers this document to the company secretary.
Step 4: The company secretary issues and holds on to the share certificates
On the Purchase Date, the company secretary issues share certificates in the name of the employee/consultant, who then becomes a company shareholder.
The number of share certificates and 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.
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.
The company may exercise its buyback right for three months after the employee/consultant leaves. The buyback right is deemed to be automatically exercised by the company upon the expiry of the three months.
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 (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 cancelled. Ensure the company secretary files 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 company’s decision-making).
The company may exercise the call option for six months after the employee/consultant leaves the company.
Share Options vs Share Vesting
In a nutshell:
- 1st Step: A company’s board of directors will grant share options to key employees (beneficiaries of an Employee Share Option Plan or ESOP).
- 2nd Step – The exercise of those share options is conditional upon completing pre-set conditions.
- 3rd Step—Share vesting occurs upon the completion of all pre-set conditions: new shares are allotted, or existing shares are transferred to the beneficiaries.
In detail:
Share options are meant to create incentives for the key/senior employees or executives (directors) to stay in the company and increase profitability. Employees holding share options will be motivated to increase the value of their shares and will eventually enable long-term value creation.
A share option plan ultimately aligns the interests of the employees with those of the shareholders and the management, creating a shared stake in the company’s results. It represents a significant step toward a company’s better corporate governance.
A clear understanding of the basic option terms is essential for drafting the detailed terms of a share option plan.
The summary below will provide some guidance towards the mechanisms of a share option scheme, where share grant options limit a private company.
Share options
A share option gives an employee the right to access the company’s share capital in the future. When an employee owns a share option, it is crucial to remember that he/she does not yet own any share in the company.
The mechanism of a share option is similar to that of a call option as it gives its holder the right to buy shares at a pre-determined price only if certain conditions are met.
An option is a right and not an obligation, meaning the employee cannot be forced to purchase the shares. On the other hand, by granting share options to an employee, the company undertakes to issue the said shares upon satisfaction of the pre-determined conditions and exercise of the options by the employee.
What does a company grant when granting share options? A share option gives conditional access to one or several share(s) of the company. A share option does not grant the employee any of the rights attached to shares, which means that the employee is only entitled to participate in general meetings or to receive dividends once the shares are effectively allotted.
Share options are generally granted for free and cannot be transferred nor sold to other persons by the grantee.
Share vesting
As a share option plan is generally conditional upon the employee satisfying several pre-set conditions or upon the occurrence of pre-set events, the share vesting is the acquisition of the actual right to exercise the options.
