ESOP – a summary of a series
Each journey has its destination. With this in mind, it is time to wrap up our series of articles on ESOPs. Our ESOP journey together has started where all ESOPs began, namely with the USA (see our article on Silicon Valley Standards And CEE Realities). We then delved into the issue of ESOP models and how they can be structured in terms of investment rounds in a company. We also commented on the issue of communication with employees, types of grants and their characteristics. Finally, equipped with this extensive knowledge, we touched on more specific aspects such as ESOPs in foreign companies and its influence on ESG metrics of the company. As such, it’s time to summarize!
ESOP – Why is it worth implementing?
First of all, an ESOP may come in handy for less well-off companies as a form of additional remuneration for its employees. It can also serve as a tool to attract the best talent. As with a good medical healthcare plan, ESOP can be an extra benefit for the employee, persuading her or him to join the particular company. Experienced employees, usually those in the IT sector, will nowadays often not be satisfied with the “usual” benefits such as health care, sports card, fruit Thursdays, pizza Fridays and so on. Above all, they will also expect a rewarding ESOP program.
Let’s not forget about other important factors! Incentive schemes foster a mindset of owning a part of the company which the employee works for. It gives them the motivation to maximize the company’s growth and profit. ESOP can also do wonders for retention of employees and their general morale. Incentive schemes allow them to feel included and a part of something bigger, which creates a mutual interest in developing the success of the company. Also, ESOPs help to transform the ownership structure of the company to one in which the workforce can also decide on matters of importance, which is in line with current ESG trends (in terms of social and governance). Therefore, if you are looking for improvement of ESG metrics by way of reducing workforce turnover and contributing to social inclusion, ESOP is a perfect tool.
To sum up: if properly implemented, ESOP will motivate employees to work better and more efficiently, which is a win-win situation for both the employee and the company itself.
ESOP Differences Comparing CEE to USA
As already mentioned, ESOPs in CEE are generally not fully regulated. This can be seen either as a tool to allow flexibility in the chosen model, or as a cause for concern due to the potential uncertainty of legal consequences (e.g., how the chosen ESOP model will be taxed). The situation is quite the opposite in the US, where all ESOPs are standardized and based on a uniform set of documents. According to a May 2019 EFES (European Federation of Employee Share Ownership) study, this lack of uniform European regulations is a major handicap to the greater popularity of ESOPs in Europe, compared to the US.
ESOP Models
To summarize the ESOP constructions which may be used in Poland, the following models are available (depending on the type of grant for the beneficiaries):
Stock-based
In this model, real shares are granted to the participants (with all rights of the shareholders attached, such as a right to dividend, voting rights etc.). The shares may be acquired by the ESOP participants in stages, according to an adopted vesting schedule – or they can be subject to so-called reverse vesting, when they are acquired all at once, but some portion can be repurchased by the company (decreasing in accordance with the adopted vesting schedule).
Option-based
In this model, only the right to acquire shares in the future is granted to the participants. At the moment of the grant, beneficiaries are not awarded any real shares.
Phantom-based
An ESOP based on phantom shares entitles its participants to receive a cash equivalent corresponding to the value of virtual shares granted. Beneficiaries receive no shareholders’ rights or obligations.
Each of the models outlined above have their respective pros and cons, as well as influence on the corporate governance of the company.
What you should consider while deciding on ESOP?
There are some things you have to bear in mind when deciding on an ESOP. What will come as no surprise, first factor to consider is the type of award to be granted. Second would be the length and conditions for vesting (do you want to link the vesting with the achievement of certain KPIs?). Another aspect concerns the impact that the implemented ESOP has on future investment rounds. Within that context, it’s necessary to reserve an adequate share pool for the incentive scheme (10% at seed level is nowadays regarded as a market standard). Moreover, you have to think about the definition of an “exit event” and what happens with the ESOP on occurrence of such an event – should the beneficiaries sell their stock or stay at the company?
As you can see, the number of questions multiplies as you delve deeper into the subject, but don’t worry – the most important point is to have a general overview of what your ESOP should look like. With that set, further specifics can be worked through. Also, when it comes to the detail, you can always seek professional advice.
We’re happy to see more and more ESOPs in our daily practice. With the current phenomenon of “quiet quitting”, ESOPs can prove a fantastic tool to motivate employees and keep them at your company. Even though CEE regions still have much to learn from the best Silicone Valley standards, we tend to lean towards positive thinking in line with the saying: it seems impossible until it’s done.
Related Posts:
ESOP For Startups: How Employee Stock Option Plans Can Improve ESG Metrics? (by Mateusz Kaczmarski, B2RLaw)
ESOP For Startups: ESOP In Foreigner’s Companies – The Consequences For Employees In CEE (by Magdalena Zawiślak, Associate, B2RLaw)
ESOP For Startups: All You Need To Know About Granting Shares And Options (by Teresa Pilecka-Juda, Senior Associate, B2RLaw)
