Introduction
As the name suggests, Employee Incentive Plans are typically put in place to motivate and reward employees for their performance, productivity, and contributions to the company’s success. These Plans are commonly adopted as they have been shown to:
1. Boost motivation: Incentive plans provide employees with tangible rewards or recognition, motivating them to achieve individual and organizational goals.
2. Improve Performance: By tying rewards to specific performance metrics, incentive plans encourage employees to enhance their skills and contribute more effectively to the company's objectives.
3. Enhance Retention: Offering attractive incentives can increase employee satisfaction and loyalty, reducing turnover and retaining key talent within the organization.
4. Align Interests: Incentive plans align the interests of employees with those of the company, fostering a sense of ownership and commitment to shared goals.
5. Encourage Teamwork: Team-based incentives promote collaboration and cooperation among employees, leading to improved teamwork and collective success.
6. Attract Talent: Competitive incentive packages make a company more appealing to prospective employees, helping attract and retain top talent in the industry
Types of Employees Incentives Plan
Although various Employees Incentives Plans exist, Companies typically utilise any one or a combination thereof of the following Plans:
1. Employee Shares Option Scheme (ESOS): Most commonly adopted, this scheme grants employees the right to purchase shares in the company at a predetermined price within a specified period. This allows employees to become partial owners of the company and benefit from any increase in the company's stock value over time;
2. Phantom Share Option Plan: A phantom share option plan is a form of employee incentive plan where participants receive hypothetical units or "phantom shares" linked to the company's stock performance. Unlike traditional stock options, no actual shares are granted. Instead, participants receive cash or its equivalent based on the increase in the company's stock value. It allows employees to benefit from the company's success without actual ownership;
3. Share Award Scheme: A type of employee incentive plan where a company grants its employees actual shares in the company outright as a form of reward or incentive. This can be distinguished from share options, which give employees the right to purchase shares at a predetermined price and at a later date.
For the purpose of this article, the focus shall be centered around the mechanics of a traditional ESOS.
How do Employee Share Option Schemes Work?
Share options are agreements between a company and its employees that grant the employees the ability to purchase (exercise) a specific number of company shares at a predetermined price, thus allowing them to become shareholders in the company.
However, before employees can exercise their right to buy shares (share options), they must work for the company for a specified amount of time or meet certain conditions (vesting), which incentivizes them to remain with the company and perform well.
Once the options have vested, there is a limited amount of time (exercisable period), during which the employees can exercise their right to purchase the shares. It's important to note that this period also includes a specific time frame after an employee leaves the company.
Picturing how a traditional ESOS arrangement works in Malaysia
To better understand such an arrangement, we can follow a hypothetical timeline:
Ø Let's say that Jane hired by Company ABC Sdn. Bhd and as part of her employment package, she is granted options to purchase 5,000 shares of ABC Sdn. Bhd.’s stock at a price of 10 sen per share, which is the fair market value at the time of the grant.
Ø The options have a vesting period that is purely based on time, with a 2-year cliff and a 4-year vesting period. This means that Jane must remain employed by ABC Sdn. Bhd. for 2 years before she can exercise 25% (1,250 shares) of the options. The remaining 3,750 options vest over the next 4 years, at equal monthly intervals.
Ø If Jane leaves ABC Sdn. Bhd. before completing the second year, she will not be entitled to any of the options. However, after the options vest or become exercisable, Jane can purchase the shares at the agreed-upon price of 10 sen per share, regardless of whether the value of ABC Sdn. Bhd.’s shares has increased significantly. If Jane remains employed by ABC Sdn. Bhd. for 6 years, all of her 5,000 option shares become vested.
Ø Now, let's imagine that ABC Sdn. Bhd. goes public and the share value rises to RM10 per share. Jane decides to exercise her options and purchases 5,000 shares for just RM500 (5,000 x 10 sen). She then sells her shares at the publicly traded price of RM10 per share, earning RM50,000 and making a gain of RM49,500.
In summary, ESOS involves the grant of options to purchase company shares to employees, with a vesting period that is often based on time or performance. Once vested, employees can purchase the shares at a predetermined price and potentially make a significant gain if the company's share value increases.
ESOS jargons to familiarize with
Share options: It's important to distinguish between share options and the actual shares themselves. Owning shares means that the person is already a shareholder in the company and has voting and dividend rights. On the other hand, having share options means that the person has the right to purchase shares in the future, but they are not considered shareholders until they exercise the option.
Grant date: Also referred to as the offer date or award date, marks the official date when the share options are awarded to the employee and the vesting period begins.
Understanding the benefits of offering share options is essential to begin with. For the company, it provides an effective way to attract talented individuals, align them with company goals, reward them collectively and reduce cash burn.
On the other hand, for employees, it offers an opportunity to receive compensation that may have a significant upside value and aligns their financial outcome with the future and performance of the company.
Vesting periods: Typically these periods typically follow either a time-based, milestone-based, or hybrid approach. During this period, employees are unable to exercise their options. For instance, the terms of an ESOS may dictate that the options only vest if certain conditions are met, such as the company achieving a specific annual turnover and the employee remaining employed for a designated period. The longer an employee stays with the company, the more options they receive. For example, 25% of the options may vest after one year of employment, with the remaining 75% being awarded over the next three years in equal instalments.
Exercise Price/Offer Price: The price per share the employee must pay the company in order to purchase each share under the employee share option scheme. For example, 5,000 shares at an exercise price of 10 sen per share means the employee pays the company RM500 to subscribe for 5,000 shares.
Exercising Options: means to purchase shares at the predetermined exercise price. After the vesting period is over, employees can exercise their right to buy the shares, but it's not mandatory. The exercisable period is the time frame in which employees can exercise their options, starting from the first day it becomes exercisable until the last day it can be exercised. If an option is not exercised by the end of the exercisable period, it will expire.
Frequently Asked Questions (FAQs) on ESOS
Who can award or administer ESOS?
As per the rules outlined in the By-Laws, the management of ESOS usually falls under the responsibility of the Board of Directors. They have the authority to designate a subcommittee, a specific director, or a member of the management team (such as a hired CFO, COO, HR personnel, or founders) to oversee the ESOS on behalf of the Board.
Who can be awarded?
ESOS primarily target employees and directors under valid employment contracts.
How much Options should be allocated?
Typically, companies set aside approximately 10% to 15% of their total shares on a fully diluted basis for ESOS, as a general guideline. However, this allocation serves as a maximum limit, and the company isn't obligated to distribute or use all options immediately. Issuing a significant number of options may lead to future dilution of the company's equity when these options are exercised.
How much should the exercise price of the Options be?
The determination of this rests as a commercial choice within the purview of the Board or its sub-committee managing the ESOS. The establishment of the exercise price varies between private unlisted entities (such as early-stage startups or SMEs) and publicly listed companies, which are bound by the Bursa Listing Requirements.
What are the documents typically required to implement an ESOS?
A comprehensive ESOS generally consists of a compilation of By-Laws, Offer Letter, and Exercise Notice. These are customizable documents that significantly influence the overall outcome and legal ramifications for both the participant and the company. Publicly listed firms are additionally obligated to adhere to the Bursa Listing Requirements, which might undergo periodic amendments.
The content presented in this article is meant solely for offering general information and should not be considered as legal opinion or professional advice.
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