Whether you’re a new business owner or an established one, you’ll want to bring in and keep the top-notch employees to work at your company. To do this, it is important to motivate your employees, ensuring they want to work hard for the company's success. One great way to achieve this is by offering extra benefits in the form of an Employee Stock Option Plan more commonly known as ESOP.
To understand more about what ESOP is and why it can be beneficial for your company, check out our thorough explanation below!
What is ESOP?
ESOP allows employees to buy company shares at a fixed price within a specified time. Usually, employees are granted ESOPs with conditions like they have to work at the company for a specific period. In Singapore, the Employee Stock Option Plan (ESOP) is one of the most popular employee benefits used by companies to attract and retain talented employees.
ESOPs are regulated by the Inland Revenue Authority of Singapore (IRAS). Employers must also comply with specific rules that the IRAS has established, and communicate everything clearly with employees; from the plan's terms, and even the tax implications.
6 Different Types of ESOP Available for Companies to Adopt
To ensure that the company can implement the right ESOP that fits its needs, 6 different types of ESOP can be explored and chosen based on the company's preferences.
1. Incentive Stock Option (ISO)
ISOs are a type of stock option granted to employees by their company. They provide employees with the right to purchase company stock at a predetermined price, which is usually below the market price. But this opportunity will be present only at a specific period. ISOs have certain tax advantages compared to other types of stock options, such as favorable tax treatment upon exercise if certain conditions are met.
2. Employee Stock Option Scheme (ESOS)
ESOS is a scheme implemented by a company to grant stock options to its employees as a form of compensation. Under an ESOS, eligible employees are granted the right to place company stock at a predetermined price, within a specified period. ESOS is often used as a tool to incentivize and retain employees.
3. Employee Stock Purchase (ESP)
ESP program allows employees to purchase company stock at a discounted price. Usually, companies will offer payment methods through payroll deduction. Employees contribute a portion of their salary towards purchasing company stock, and at the end of a defined offering period, the company will use these funds to purchase shares on behalf of the employees at a discounted price.
4. Stock Appreciation Rights (SARs)
SARs are a form of equity compensation where employees receive appreciation in the value of a certain number of company shares over a specified period. Unlike other stock options, SARs do not require the employee to purchase the underlying stock. Instead, employees receive cash or additional company stock equal to the increase in the stock price from the grant date to the exercise date.
5. Restricted Stock Unit (RSU)
RSUs are a form of equity compensation where employees receive units representing company stock, but these units are subject to certain restrictions, such as a vesting period. Once the restriction lapses or the vesting period is complete; employees will receive actual company shares or the cash equivalent of the shares.
6. Restricted Stock Award (RSA)
RSAs are pretty similar to RSU, as they both involve the award of company stock subject to restrictions, such as vesting requirements. However, unlike RSUs, employees receive actual shares of company stock at the time of the grant. But, these shares can be subject to forfeiture if the employee does not meet certain conditions, such as remaining with the company for a specific period.
4 Key Components of the ESOP Agreement
The company's management board will be the one who sets the rules and the price of ESOP. But as we’ve mentioned above, the price of the shares offered is typically set at a significantly lower price compared to the market value. Generally, an ESOP agreement will include 4 important key components to be understood by both employees and the employer.
- ESOP Structure: The way an ESOP is crafted and organized depends on several factors including the company goal, its size, and the stage it's at in its development.
- Employee Eligibility: When implementing ESOP, determining employee eligibility and participation criteria is crucial. Typically, eligibility requirements are determined based on factors such as an employee's position within the company, length of service, and performance. Companies have the option to offer ESOP participation to all employees or limit it to certain groups only. It is important to communicate the eligibility criteria to the employees to ensure transparency and fairness.
- The Vesting Period: The vesting period is the duration during which an employee's shares gradually become available to them. This waiting period can act as a retention strategy, which encourages long-term commitment from the employees. Usually, this period lasts around 3 to 4 years.
- The Cliff Period: This period signifies the time an employee must remain with the company before their share options start to vest. This can act as a prevention act for employees who plan to leave shortly after joining and taking their potential shares with them.
What are the Benefits of ESOP?
Part of the Employees Compensation Package
When facing limited cash flow, companies might struggle to offer competitive salaries to attract top talent. In such cases, they can enhance their compensation packages by including share options. These options serve as a valuable supplement, helping bridge the gap between what the company can afford to pay in cash and the market salary expectation.
ESOP in particular, can effectively entice skilled individuals to join their teams, especially when employees recognize the company’s potential for growth and success.
Retaining Employees
Because ESOPs commonly include cliffs and vesting periods, this means that the employees who are participating in the Employee Stock Ownership Plan have to remain with the company so they can exercise their share options.
Build Greater Value for Employees
When employees get to buy shares in their company, it can help to increase their loyalty. If you have a limited cash flow and are unable to pay the full market salary to your employee, you can use ESOP to supplement their salary with share options.
Establish Company Image
ESOPs can foster a sense of ownership and pride among the employees, and when they feel like they have a stake in the company’s success, they are more likely to be engaged, motivated, and committed to achieving the company’s goal. This increased level of employee engagement can have a positive impact on the company’s culture and reputation. Companies who have adopted ESOP will also have a lower turnover rate, this will help to build the overall image of the company.
Attract Talented People
ESOP can serve as a powerful incentive for attracting top talent by producing a unique and valuable employee benefit. The opportunity to participate in ESOP demonstrates that the company values its employees and is committed to rewarding their contributions. Talented individuals who are seeking opportunities for growth, advancement, and financial participation may be drawn to companies that offer ESOPs as part of their compensation package.
What are the Factors to Consider When Companies Plan to Offer ESOP?
ESOPs indeed can offer significant advantages to companies who want to attract and retain talented employees. But it is important to think thoroughly before deciding to offer ESOP for employees, as implementing this will need you to entail some important considerations such as these 4 below:
- Establishing ESOP is complex as it involves amending the company's constitution and drafting detailed ESOP letters to outline program terms.
- While there's no legal constraint on the size of equity for an ESOP, companies should limit the equity offered to employees.
- Implementing ESOPs leads to the distribution of ownership equity among employees, thus reducing the percentage held by founders or owners. To address this issue, companies might need to include drag-along rights in the ESOP agreement. This clause grants majority shareholders the authority to force minority shareholders to sell their shares in the event of a company sale or merger.
- The ESOP agreement should also contain a provision as to what happens when an employee who holds an ESOP leaves the company after their shares have been vested. It should include a clause outlining the consequences.
Conclusion
If you are planning to establish a business in Singapore, having an ESOP can help to attract and retain talented employees, and provide them with financial incentives.