In today’s competitive business world, employees are key assets for any company. To incentivise employees to maintain high performance and stay with the company, as well as to align the interests of employees with the interests of shareholders, companies have frequently looked to implement long-term incentives. One popular and effective incentive is the employee share option scheme.
This article briefly summarizes employee share option schemes and key implementation considerations for private companies in Singapore.
Employee Share Options Mechanism
An employee share option scheme would typically be governed by a set of rules, which lay out a two-stage mechanism: (a) the offer and acceptance of the option, and (b) the exercise of the option.
Following the decision by the company to accord an option to an employee, the company would make an offer of options to purchase shares in the company. To participate in the employee share option scheme, the employee would be required to accept such an offer by following the instructions as stipulated by the company. This may involve the submission of certain documents and a nominal sum as consideration.
Upon the valid acceptance by the employee for such options, the employee may exercise the option to receive shares in the company on or after the vesting date, but before the option expiry date, as stipulated by the company. The exercise price is typically for a no-cash consideration or a price that is a discount to the valuation of the company, as an incentive for the employee to participate.
Type of Shares
Shares to be issued or transferred pursuant to employee share options schemes are typically ordinary shares, with preference shares (holding preferential terms) reserved for investors. The holder of ordinary shares would possess certain rights, including voting rights. For administrative efficiency, it is possible for the voting rights received by the employee to be transferred to a shareholder that is part of the management of the company, such as the founder of the company, by way of power of attorney.
Shares Issued or Transferred
Pursuant to an exercise of options, shares in the company may be issued as new shares, transferred from existing shareholders or transferred from the pool of treasury shares. For Singapore private companies, shares pursuant to employee share option schemes are typically issued as new shares to avoid stamp duties payable on the transfer of shares. While the stamp duty payable may be negligible in new or small companies, it increases in tandem with the increase in the net asset value of the company.
Implementation and Other Factors to Consider
As an employee share options schemes has an invariably dilutive effect on all existing shareholders of the company, it is necessary that, at the minimum, each existing shareholder that possesses pre-emptive rights on the issuance of shares approves the terms of the schemes. For the same reason, should there be any increase in the number of shares that may be issuable under the employee share option scheme, each existing shareholder that possesses pre-emptive rights on issuance of shares should approve such variation. The failure to obtain such approval may result in the company breaching its obligations either to the holder of options under an employee share option scheme or the rights of the shareholders under a shareholders’ agreement in relation to the company and/or the constitution of the company. The company should also take steps to amend the constitution of the company to exclude any shares issued pursuant to employee share option schemes from pre-emptive rights on issuance of shares.
In the case of new shareholders that have acquired shares pursuant to issuance of shares by the company through subsequent funding rounds, the terms of the employee share option scheme should be made aware to such investors, and the exclusion of shares issued pursuant to employee share option schemes from pre-emptive rights on issuance of shares should be retained. Depending on the terms of the shareholders’ agreement in relation to the company and the constitution of the company, this issue may not exist in relation to new shareholders that have acquired shares pursuant to a transfer from existing shareholders and have executed a deed of adherence, adhering to the terms of the shareholders’ agreement in relation to the company.
It should be noted that if the company had adopted the model constitution, there is a built-in pre-emptive right on issuance of shares accorded to each shareholder wherein any new issuance of shares should be offered to each existing shareholder in proportion to their existing shareholding in the company. Accordingly, a person that becomes a shareholder of the company pursuant to shares issued or transferred under an employee share option scheme will possess pre-emptive rights on any issuance of shares, unless the constitution of the company is amended to exclude holders of shares issued pursuant to the employee share option scheme.