paul@paulfoleylaw.ie
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Employee Share Option Plans – a way to compete
January 2020 - For small and medium-sized enterprises (SMEs), competing against large corporates, including Big Tech is generally very difficult, whether as regards offering competitive remuneration packages or in developing competitive products.
Share option plans offer a way for SMEs to compete. However unlike plans offered by listed multinational companies (where options which vest, once exercised can be sold and the employee can realise value on them) share options offered by SME’s, once exercised, are difficult to realise value on, as the companies are not listed.
For a share option plan to enable SMEs attract, retain and motivate employees, it needs to be tax advantaged, such that gains realised on the exercise of options are not subject to income tax, universal social charge or PRSI and only capital gains tax will arise on a subsequent disposal of the shares, at which time the sales proceeds will be available to discharge the tax due. Additionally the plan needs to be exempt from employer PRSI contributions.
The Key Employee Engagement Programme (KEEP) applicable in respect of share options granted during the period 1st of January 2018 to December 2023 is such a plan, but take up has been poor due to the qualifying provisions being unduly onerous. Budget 2020 has proposed improvements to (i) allow companies who operate through a group structure to qualify for KEEP (ii) for definitions within the legislation relating to the conditions for a qualifying employee to be amended to allow for part-time/flexible working and movement within group structures (as business needs dictate) and (iii) the legislation is to be amended to allow existing shares to qualify for KEEP.
Creating an Employee Share Option Plan (Plan)
Aside from tax issues, in putting together the Plan benefits, they ought to have been benchmarked against typical plans for the sector in which the Company operates.
It is also important to establish in aggregate how many options will be granted, so that post exercise, the percentage of share capital held by benefiting employees does not exceed a benchmarked percentage of the total issued share capital. The benchmark is typically established by that percentage which government agencies might typically allow and the percentage which venture capitalists would allow, for the stage the Company is at. This can vary from between 10% to 20% of the issued share capital.
The share type included in the Plan should be ordinary shares, as the grant of options in respect of shares which have preferential rights, will invariably be contrary to Revenue rules whether as regards tax advantaged share options or as regards government schemes giving investors tax breaks on subscriptions for shares under the EII scheme.
Employees to whom options may be awarded should not have or acquire a material interest in the Company (in very net terms more than 15% of the ordinary share capital of the qualifying company).
It is important to check that the Company’s constitution does not require amendment ( for example the authorised capital may need to be increased) and if any shareholders agreement is in existence, that the Plan is consistent with it, can stand alone beside the shareholders agreement and that any provision of the shareholders agreement that require reproduction in the Plan are so reproduced. Typical would be Drag Rights.
The Plan should (even if not legally required) be put by the directors to the shareholders, and if the shareholders approve the Plan, the Board then considers and adopts the Plan.
Plans: Key Provisions
Employee Share Option Plans vary widely, but the following are issues that need to be dealt with in most Plans.
An Exit can be defined as each of the following, a Listing, a Share Sale, Capital Raising and an Asset Sale. A Capital Raising might result in new shares being issued to the incoming investor, resulting in that investor acquiring control of the Company.
The Plan should define each of these terms and what will or can happen should any of these events occur. A specific provision to deal with Capital Raisings is important, given that funding rounds are becoming more numerous and IPOs are not as necessary as in the past in order to raise capital.
It is important, that a Group Reorganisation (as defined) is excluded from the definition of an Exit and that such an event is specifically provided for in the Plan.
Sometimes a Plan will contain a roll over provision. This typically provides that if on a change of control occurring, the entity acquiring control offers to grant new options in exchange for existing options on terms it considers appropriate, the option holder is given a rollover period during which the options granted can be exchanged for options granted by the new owner.
Variation of Share Capital and Data Protection
Finally the Plan should provide for what happens if there is a variation of share capital in the Company (such as a rights issue, consolidation, subdivision or reduction of capital), and also incorporate a data protection clause compliant with GDPR, to make clear how personal data collected in implementing the Plan is processed.
January 2020 © Copyright Paul Foley – All Rights Reserved.
For advice on any aspect covered in this report, contact Paul Foley
