As a startup, you might struggle to attract and retain key talent if you are unable to offer salaries that are competitive in the market. This is why many startups incentivise and retain talent by implementing an Employee Share Option Plan (ESOP). Although you may assume that only your employees can participate in your ESOP, contractors, directors and advisors (participants) can also be included. This article will explore the key factors you must consider when involving contractors and advisors in your company’s ESOP.
What is an ESOP?
An ESOP is a mechanism for offering your employees, contractors and advisors an opportunity to own part of your company. In your shareholders agreement, you will set aside a theoretical ESOP “pool” that you and your fellow directors can allocate to potential ESOP participants.
Why Offer ESOP to Contractors and Advisors?
Your contractors will be contributing to your company’s success by providing their specialised skills and expertise to key areas of your business. Early-stage startups often engage contractors or advisors to handle specific projects. However, due to budget constraints, these startups may struggle to afford the market rate for such services. By offering your contractors or advisors ESOP securities, you can potentially reduce the amount they charge for their services.
Offering ESOP securities to contractors and advisors fosters and promotes a shared alignment of objectives and purposes. By owning a part of your company, a contractor or advisor is generally more motivated to deliver a product or service that aligns with your vision and your expected quality.
Continue reading this article below the formHow to Implement Your ESOP
Your plan rules will be the foundation of your company’s ESOP. Your plan rules set out the overall structure of your company’s ESOP. It will also dictate rights and obligations such as:
- participant eligibility;
- vesting conditions; and
- what will happen in the event a participant leaves the company.
You must then make individual offers to each participant to join your company’s ESOP scheme through an ESOP offer letter. The offer letter should set out the key terms for each participant, including:
- the number of options they are being offered;
- any restrictions on exercising the offered options;
- the price they must pay to exercise those options; and
- any vesting conditions to which their options are subject.
Your offer letter should also contain an election for the participant to designate a nominee to hold their options. For instance, they may select a family trust.
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Number of Shareholders
It is crucial to note that if your proprietary company exceeds 50 non-employee shareholders, ASIC can force you to become a publicly unlisted company. This brings with it a host of complicated financial reporting requirements and disclosure obligations when you offer shares or options. Your employee shareholders are not included in the count of shareholders. However, any contractors, directors, or advisors among your shareholders will be counted.
Additionally, it is essential to remember that selling your business will become more difficult if you have over 50 shareholders, as the “takeover provisions” will apply. The takeover provisions do not distinguish between employees and non-employees when counting the number of shareholders.
Key Takeaways
ESOPs are an excellent tool for you to attract, retain and incentivise key talent. Once you have set up your ESOP documents, you can offer them to employees, directors, contractors and advisors. There are several key points you should keep in mind when making offers under your ESOP:
- check that your offers are captured by an exemption to avoid costly and timely disclosure requirements;
- ensure your employees receive independent tax advice so that they can take full advantage of startup tax concessions; and
- if you are going to approach the 50-shareholder threshold, consider implementing a bare trust to hold shareholders or your ESOP beneficiaries collectively.
If you need assistance in drafting or implementing your company’s ESOP, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. So call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Do I have to implement an ESOP early on, or can I implement it later on?
Whilst you can implement an ESOP at any stage, it is generally simpler to allocate an ESOP pool early, even if you do not intend to use it. This is because it is easier to implement or amend your shareholders agreement when you have fewer shareholders from whom you require approval.
Why do some investors insist on startups implementing ESOPS?
In line with industry practice, many angel investors and venture capital funds will expect a startup to implement an ESOP at some stage. The dilution of shareholders’ shareholding is primarily due to setting aside an ESOP pool. Investors seek a clearer understanding of the dilutionary effect that your ESOP could have on their investment if you were to issue the entire ESOP pool.
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