Here Is What You Should Know About Employee Stock Option Plans (ESOPs) in Singapore
If you are looking to build a dream team for your company even if you are a small start-up, the best way is to offer incentives. For start-ups, this is a good strategy because normally the pay you will be offering might not compete with established enterprises in the market. In Singapore, job-hopping is growingly becoming a norm, and top talents are always seeking new opportunities where there are better perks. A start-up may need more than just compensation for it to be able to retain top talents. This is where Employee Stock Option Plans (ESOP) comes in.
ESOPs are popular incentives employed by growing enterprises and start-ups as a way of compensating employees through ways that do not affect the current flow of cash. You may get a chance to work for a company that is offering ESOPs, and you will feel that you own part of the company. Here is a guide to help you understand what ESOPs are:
What is an employee stock option plan?
An Employee Stock Option Plan (ESOP) is an incentive offered by the employer to the employee offering a chance to acquire shares of the company. Usually, the employee can purchase the shares of the company at a pre-determined price over a specified period. ESOPs are advantageous in retaining talent because employees will feel that sense of company ownership. This is a strong incentive that can lead to employees committing to the company over a long period.
Usually, a company will commit part of its total equity to offer to some of the company’s most valued employees. The exercise price set for the ESOP is usually close to the fair market value of the company shares. Offering the employees part of the company means that they are in a position to benefit in the future if the value of the company will increase. This is a good motivating factor for employees to commit themselves and work hard to grow the company.
How do ESOPs work?
As indicated, a company will offer part of its equity to employees which is a chance for them won the company. The shares an employee will hold will increase in value should the value of the company increase. Equally, if the value of the company declines, so will the value of shares an employee holds in the company. However, these are not shares but unvested stock options.
This means you will have a right to purchase a given amount of the shares once you fulfill certain conditions like being in the company over a given period. There is the lock-in period which means you will need to be in the company for a given period before getting the option of accumulating share options through ESOP. The shares will typically take three to four years in what we call the vesting period before the employee’s shares to begin being drip-fed over time. After meeting the conditions, the employee can then exercise the option of purchasing the stock and become vested.
It is important to remember that in most cases, ESOPs come at the expense of pay. Sometimes companies can choose between higher pay without the options or a lower salary with ESOPs. Taking the ESOPs usually is a gamble because it depends on whether the company will succeed, and if it doesn’t, you will lose. The vesting period is also another thing to keep in mind, and if the company expects you to stay for a while for you to vest ESOPs, then it is not worth. You could lose all your rights to unvested ESOPs if you quit.
Rules and regulations around ESOPs
Despite having numerous benefits to the employee and the employees, ESOPs have several factors to consider. Although setting up an ESOP may look flexible, the procedure of setting one up is complex and involves several rules and regulations. There are different scenarios to look at in each aspect, and it has to involve an attorney.
Although there is no law governing the quantity of the ESOP, the company needs to set a limit of the amount they want to share. For instance, a company may decide to offer 5% to 15% of the equity as ESOP and say that each employee should be entitled to around 0.5% to 3%.
ESOPs usually dilute the company’s equity as ownership will now be between several individuals. The founder may end up with a small part of the company, and this complicates things during mergers or when the exiting. To avoid such a scenario, the board should include a drag-along clause, which permits majority shareholders push minority stockholders sell their stake; if there is a third party offer.
You are required to pay tax on the ESOP because it is part of the compensation package. Income tax is charged on any profits or gains accruing from the exercise of ESOP. If your ESOP has no vesting period, then you will start paying income tax on gains immediately you execute the ESOP. The only exception is when there is a limit on selling the stocks where you will pay tax in the year you will sell the shares.
ESOPs are incredible in helping tech companies, and start-ups grow and save money. It helps the firms to offer employees lower salaries as they grow. Equally, it’s an important way for start-ups in Singapore to retain top talents, especially in this era where job-hopping is increasingly becoming popular. For employees, this is an amazing opportunity to build something big; that is if you see the potential of a start-up growing its value. You will become part of the company and help build the company because success to the company means deep pockets for you also. However, this is always not a guarantee that the start-up will grow in value as sometimes a business might not pick up. Be cautious also when you have a company that offers ESOPs with a very long vesting period because this might not be worth the time you spend in the company.