It is common for startups to implement employee share option plans (ESOPs) as a staff incentivisation tool. An ESOP allows employees to receive options in your company with favourable tax treatment. Accordingly, your employees can receive a financial benefit from those options if they stay on for an extended period and help the company grow in value. In this sense, an ESOP can help align your employee’s and the company’s financial interests. This article explains what an ESOP is, how an ESOP works and how you can issue an advisor options under an ESOP.
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.
Can I Offer Options to an Advisor?
An advisor can be an invaluable person to engage when starting up your new business. A great advisor can bring a significant amount of knowledge and experience in your particular industry or a high amount of business acumen. They can advise you on particular parts of the business or on running a business generally. If you incentivise business advisors appropriately and form a great partnership, you can utilise their knowledge and experience to grow your business.
Provided the advisor agrees to payment in options, you can issue them options for their advisory services. You may also engage the advisor and compensate them with a mixture of options, shares or fees.
What is an ESOP?
An ESOP is a scheme where you offer your employees, contractors (including advisors) or directors options in your company. An option is a right to acquire a share in your company upon certain conditions being met. One option usually converts into one share.
For this article, we will focus on issuing options to advisors.
Exercise Price
When an option converts into a share, the advisor will have to pay a price. This amount is known as the exercise price or the strike price. However, options do not carry voting rights or the right to dividends. Instead, voting rights and rights to dividends are only available if and when the options convert into shares.
When you issue options to an advisor, the exercise price must not be less than the market value of shares in the company. However, provided certain criteria are met, the favourable tax treatment for a startup allows options under an ESOP to be valued using different valuation methods. This may result in a lower price than a full market valuation of the company.
Vesting Period
The options will vest gradually over a set period. While your startup will issue all options to the advisor up front, they will earn the value of the options over a period of time.
The advisor cannot exercise an option until it has vested and the exercise conditions are met. Two exercise processes that can be implemented include:
- the option is exercisable as soon as it vests; or
- the option is exercisable only on an exit event (i.e. sale of the business (through either a business or share sale) or a listing on a stock exchange).
Where the advisor ceases providing their advisory services before the end of the vesting period, any unvested options will lapse. Consequently, they will receive no value for these. Your startup company must either:
- buy back options at market value;
- transfer options to another shareholder or optionholder for market value; or
- the board of directors can decide that the advisor can keep their vested options.
Favourable Tax Treatment
Where your company issues options to an advisor, they will only pay capital gains tax on their options when they receive a financial benefit, namely, when the advisor sells the share.
Continue reading this article below the formKey Points to Consider When Administering an ESOP
You should enter into an advisor agreement with the advisor to document their role and responsibilities, confidentiality and intellectual property aspects, and their compensation. You should also prepare appropriate ESOP offer documents and provide them to your advisor. This will ensure clarity as to how many options they have been offered, what their vesting conditions are and what their exercise price is.
Internally, it is important to manage your ESOP well. As a starting point, you are legally required to maintain an options register containing the following information about each option holder:
- full name;
- residential address;
- date of entry into the register;
- date of granting the relevant options;
- number and description of shares or interest over which options were granted (e.g. 200 ordinary shares);
- period in which the options may be exercised;
- any conditions to the exercise of the options;
- grant price (often zero); and
- exercise/strike price.
Key Takeaways
Your startup should consider implementing an ESOP to provide a great incentive for employees, contractors, directors, and advisors. Recipients of options under an ESOP that qualify for the startup tax concessions offer favourable tax treatment. Overall, ESOPS are a great incentivisation tool.
If you have any questions about engaging an advisor, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to solicitors to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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