Employee Share Option Schemes are formal plans made available to eligible employees of a company that allows them to participate in the long term value growth of the business through the purchase of an ownership interest in the form of shares. Employee share schemes vary in terms of type and regulation between companies and countries, whose objectives include to attract, recruit, retain and motivate employees. However, the primary intention of these schemes is to align employees’ interest with those of the company owners and increase employee organizational commitment.
Legal and Regulatory Framework
Governance provisions of ESOPs in Kenya include the Companies Act 2015, the Capital Markets (Collective Investment Schemes Regulations 2001), Trustees (Perpetual Succession) Act Cap.164 and other applicable laws such as Employment Act that provide for rights and obligations of employees, and Tax Laws touching on fringe benefits and distribution of income.
Operational Mechanisms of ESOPs
Generally, there are three types of schemes: –
i. Share Option Scheme– employees are granted the option to purchase the shares at a pre-determined price within strict time limits. Upon exercise of the option (purchase), the share can vest immediately or after a pre-determined interval.
ii. Share Save Scheme – eligible employees save on a predetermined basis towards shares reserved for them. This is based on a savings contract.
iii. Unit Scheme– the shares are held by the ESOP trust established for that purpose. The trustees purchase shares of the company and eligible employees subscribe to units that represent shares in the company. Rights and obligations of the parties are governed by the Trust Deed and Rules of the scheme and not under any procedure set out in law.
Requirements for ESOPs established by a Listed Company
The Capital Markets (Collective Investment Schemes) Regulations 2001 sets out reporting requirements for an ESOP established by a listed company. Listed Companies must apply for the approval of the Capital Markets Authority to set up an ESOP. Additionally, they are required to disclose any options granted to its employee, also disclose in annual reports the total value of the ESOP including the number of shares and number of units created and issued.
What to consider when issuing your company’s shares to employees?
It is now becoming common for companies, whether public or private including family-owned entities to allow their employees to acquire shares in the company at a lower price than the market value. No matter the motivation for implementing such schemes, they should be properly thought out, and clearly documented in order to minimize the risk of a disputes after implementation, or should the business relationship end.
Some of the areas where disputes may arise in such employees share ownership schemes include:
a) The types of shares that will be issued or transferred to the employee;
b) The market value of these shares at the date of issue;
c) How the shares will be paid for, as well as the tax implications;
d) Whether the redundant assets or liabilities (like existing shareholders’ loan) will be factored determining the fair value of these shares;
e ) How the shares will be valued on termination of the business relationship.
Shares, Share Price and Transfer of Rights
In most cases, business owners or board of directors may wish to issue shares to the eligible employees without losing control of the company. Typically, such shares would have restricted voting rights but have a right to dividend and income distribution. To achieve this, the board would be obligated to create different classes of shares and ascribe different rights such as payment of dividends, voting rights and procedures regarding issuance of new shares or transfer of shares.
A company can re-designate its existing issued shares as ‘A’ Ordinary Shares and issue new shares called ‘B’ Ordinary Shares to qualifying employees. In such a case the board may decide to pay certain amount of dividends on the ‘A’ shares and a different or no amount on the ‘B’ shares. Further, the ‘B’ shares would not be entitled to shares in any surplus left after repayment of the shareholders in the event of the company being liquidated, otherwise sold to third parties.
In the event holder of ‘B’ shares decide to leave the company’s employ (as an employee and/or as a director) they will be obligated to offer their shares for sale, with any share transfer being at the discretion and control of the board. Moreover, in default thereof within a given period after ceasing to be an employee, the company is bestowed the powers to effect the transfer on their behalf (this is called a “deemed transfer provision”) and ensures that shares do not pass outside the company’s existing shareholders without the approval of the board and/or the other shareholders.
Conclusion
Employee Share Ownership Options are additional reward mechanisms significantly associated with high performance, commitment and staff retention while presenting the company as an employer of choice.
Issuance of shares to your employees or appointment of any of your employees as a new director with a right to acquire shares in your company may require: –
- Conduct of corporate and tax due diligence exercise to determine compliance and regulatory issues before setting up an ESOP;
- Amendment of existing articles of association or adoption of brand new articles of association with such provisions; and
- Increase of share capital, if the authorized share capital is insufficient for the allotment of shares under the scheme;
To discuss the options that are available for your company, please do not hesitate to contact us through email info@bellmacconsulting.com.
