In terms of investment, start-ups and corporate law, the term “vesting” in general refers to the right of employees to acquire company shares of their employer company under certain conditions. Vesting plans are a perfect option for developing companies to acquire a new talent and even more important to keep this talent in the company. A reasonable paycheck is often not enough of an incentive for a valuable employee to stay in the team for a period of several years. Thus, vesting options have become increasingly popular in the startup world. In Singapore, a more popular term for this is “Employee Stock Option Plan”, or shortly ESOP.
How to set up an Employee Stock Option Plan?
If you want to provide the employees in your company with vesting options, the way to do this is through an ESOP agreement. This agreement creates a pool of shares that are available for employees to acquire.
If you offer your employees a stock option plan this doesn’t mean that they automatically acquire the respective shares of your company. The plan is a promise that the employee will be able to exercise their right to own the shares once certain criteria are met.
The shares may be acquired automatically by the employee but it is more common to provide the employee with the option to acquire the shares at a certain discount, usually 20-30% of the market value of the share.
An important thing to keep in mind when setting up a vesting scheme for your company is to consider the limit on the amount of equity that it wishes to share with the employees. You should only put a certain amount of shares in the vesting pool, usually no more than 15%. You can also limit the amount of shares a single employee can acquire under the ESOP.
What are the terms of a common ESOP Agreement?
Usually, important aspects of an ESOP agreement cover a cliff or a vesting period, share acquisition criteria and selling restrictions. We will cover these below.
What is the cliff period?
A cliff period is a period before an employee can exercise their right to receive company stock options. In your ESOP agreement, you may state, for example, that only employees who have been part of the company for 12 months are entitled to this option.
What is the vesting period?
The vesting period is similar to the cliff period. The vesting period starts once an employee obtains company shares. During this period the employee must remain in the company and if he fails to do so, he will lose the shares or will merely acquire pro-rate stock options.
What are the selling restrictions for stock options?
Imposing selling restrictions means that an employee can not sell their shares unless certain conditions are met. In most cases, the option to sell the shares is available to the employee after a certain period of time.
The selling restrictions may also apply to the range of persons to whom the shares may be offered or to the price of the shares. The employee may, for example, be obligated to first offer the shares at their market value to the company to buyback.
Employee Share Ownership (ESOWs)
The Employee Share Ownership is another vesting option for your company. The difference between ESOPs and ESOWs is that in the case of share ownerships the stocks are distributed among employees upfront automatically and employees don’t need to explicitly exercise their rights. Vesting and cliff periods can also be applied to this scheme through various share distribution schedules.
Taxation of Employee Stock Options
In Singapore stock options are considered part of the employee’s compensation package. How exactly the ESOP will be taxed depends on the conditions under which the employee acquires the company shares. Vesting periods and selling restrictions may delay the taxation of the acquired stock options but eventually, any gains arising from exercising share options will be taxed.