In Short
- Increasing an employee’s ESOP allocation usually requires board or shareholder approval and compliance with your ESOP Plan Rules.
- Consider vesting schedules and tax concessions when adjusting existing or issuing new ESOP options.
- Keep accurate records of all options issued and understand potential share dilution when employees exercise options.
Tips for Businesses
Before increasing ESOP allocations, review your company constitution, Plan Rules, and corporate approvals. Align any new or amended options with existing vesting schedules and consider tax implications for employees. Maintain a clear option register and update your capitalisation table to show potential dilution, ensuring transparency for investors.
Suppose you have set up an Employee Share Option Plan (ESOP) to attract and retain talent as an early-stage business. However, circumstances might require you to make further allocations to employees, contractors, directors or advisors who already hold ESOP options (ESOP participants). This article will discuss what is required to increase an employee’s existing ESOP allocation, as well as some key considerations you will need to consider when doing so.
LegalVision’s Employee Share Schemes Guide is a comprehensive handbook for any startup founder or business owner looking to attract and motivate top employees with an Employee Share Scheme.
Corporate Approval To Increase ESOP Allocation
Your starting point is always to understand what corporate approvals you require to:
- make offers to participate in your company’s ESOP; or
- change your ESOP Plan Rules.
Your corporate approvals will be contained in your company’s constitution or shareholders agreement (if you have one in place). Therefore, there is a good chance you will require board or shareholder approval to make initial and additional offers under your ESOP.
ESOP Plan Rules
You will need to check the provisions of your ESOP Plan Rules to determine whether there are any limitations on the number of ESOP options you can offer to any employee.
Most plan rules will delegate power to your company’s board to amend an ESOP offer. If so, you can change the number of ESOP options allocated to an existing ESOP participant via a deed of amendment. Directors will need to then sign the deed of amendment together with your ESOP participant.
If you cannot amend an existing ESOP offer, you can still increase your employee’s allocation by making a new additional offer. Nevertheless, you will need to consider two main points.
1. Vesting
Many early-stage companies will issue ESOP options subject to vesting provisions. Vesting provisions subject your employee’s options to a time-based release mechanism. Therefore, if your employee leaves the company before any options vest, they must surrender their unvested options.
Suppose you can amend the employee’s existing offer, depending on your rationale for increasing your employee’s ESOP allocation. In that case, you should consider whether you would like to amend the existing vesting period for any options which have not been vested yet.
Alternatively, suppose you are making a new offer to increase your employee’s allocation. In that case, you should consider whether their new ESOP options will:
- vest on a new timeframe; or
- whether it should be amended to better align with their existing vesting schedule.
2. Tax
One of the key attractions in Australia for your ESOP participants is the startup tax concessions that may be available depending on your company’s and employee’s circumstances. Where your company and your employee qualify for the tax concessions, the two main benefits include:
- the ability to defer paying tax on their options to a later tax year which can benefit your employees when it comes to tax planning; and
- eligibility for a 50% Capital Gains Tax (CGT) discount if your employee holds their options for at least 12 months.
ESOP Offers
Once you have sought your requisite corporate approvals, your offer will need to set out the critical offer terms, including:
- the number of options being offered;
- the price they must pay to exercise those options; and
- any vesting conditions which their options are subject.
Key Takeaways
ESOPs are an excellent way for you to attract new talent and retain existing talent. As part of your ongoing relationship with your employees, you may need to increase or vary their ESOP allocations. You should speak to your accountant and tax advisor when changing your ESOP policy or employee offers and encourage your employees to seek independent tax advice.
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Frequently Asked Questions
Yes. It is mandatory to keep a register of all optionholders in your company. If you issue additional options to an existing optionholder, you must make an additional entry for that optionholder in your option register.
Dilution only occurs when options issued under your employees exercise their ESOP options and convert to shares. However, suppose you plan to conduct a capital raise. In that case, most investors will expect to understand how much of the company their investment would get them if all options were theoretically exercised and converted into shares (fully-diluted shareholding). Therefore, you will need to include this information in your capitalisation table.
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