Basics of an ESOP
An Employee Share Option Plan (ESOP) is an incentive plan whereby executives and employees are granted with certain derivatives or shares of the employer company or its parent entity. The objective is to reward their past performance, encourage future commitments and attract new talent.
Under an ESOP, the company often grants share options which can be exercised when certain conditions are fulfilled. Upon exercising the options, the employee may obtain the company’s shares by paying an exercise price which is specified when the grant is made. The grant may also take the form of shares which are given to the employee on a conditional basis (commonly known as restricted shares) and the employee may or may not be required to pay a fixed price for the shares. Another type of ESOP is a shadow plan whereby the company pays out cash bonuses to employees, the amounts of which are objectively calculated based on the future growth of the company, e.g., the extent of increase in profitability or in share price (for a listed company) compared with the time of grants.
The terms of the ESOP are tailor-made based on the company’s own human resources strategies, and usually set out the form of the incentive, administration of the plan, eligibility of grantees, any limit of grant to an individual, circumstances that unvested grants will lapse and clawback mechanisms (e.g., upon the employee’s resignation, dismissal by the employer). Subject to the terms of the ESOP, the company may stipulate vesting conditions for individual employees (e.g., service period, the company’s financial performance, such employee’s own key performance indicators).
An employee may make a profit equivalent to the difference between the price he/she has to pay and the market price or fair value of the company’s shares when the vesting conditions are fulfilled. On the company’s side, ESOP is a useful tool to reward and motivate employees by granting them equity interests to share the future growth of the company. ESOP is also seen as an alternative way to incentivize key persons for the company to achieve IPO (by then, their return on the ESOP grants are usually quite substantial) while the company needs not pay them high salaries in cash before the IPO is completed.
There is no universal rule on how large the grant pool should be unless the company is a listed company and is thus subject to the regulatory requirements. Depending on factors such as industry sector, size of the company, types of talent to be attracted and management culture, companies are willing to offer between 5% to 20% of its total share capital.
Company and securities laws
Where an ESOP involves grants in Hong Kong, whether it is a plan of a Hong Kong or overseas company, it is still subject to Hong Kong company and securities laws including the Companies (Winding Up and Miscellaneous Provisions) Ordinance and the Securities and Futures Ordinance. If a grant offer is made to (i) a bona fide present or former director, employee, officer or consultant of the company or its group company, (ii) a bona fide dependent of any such person or (iii) the trustee of a trust for such persons, then the offer is exempted from the Hong Kong prospectus requirement. However, the following warning statement should still be included in the ESOP:
“WARNING: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. You are advised to exercise caution in relation to the offer. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice.”
A Chinese translation of the above warning statement should also be provided.
An ESOP typically excludes the employee’s rights under the plan from the damages that can be awarded to the employee on termination of employment… READ FULL ARTICLE
Note: This material has been prepared for general information purposes only and is not intended to be relied upon as professional advice for any cases. Should you need further information or legal advice, please contact us.