Employee share option plans (or ESOPs) are a key tool for startups to incentivise staff and hire talent when funds are tight.

However, not all ESOPs are made the same. To make it easy, we’ve put together this guide to help you through the main commercial questions you need to consider. If you want some guidance on the process of adopting your ESOP, setting up the option pool, and granting options, read our guide on how to set up an ESOP.

1) how big should your pool of options be?

Usually an ESOP pool is around 7.5-15% of a company’s total shares on a fully diluted basis (10% is most common). If you are setting up an ESOP as part of a capital raising transaction, your incoming investors may have specific requirements around this.

Generally speaking, founders are expected to take on the dilution from setting up an ESOP pool, and investors are not (i.e. an investor’s agreed stake in the company is calculated on a fully diluted basis, taking the ESOP pool into account even if the ESOP has not been formally put in place yet).

This means it’s important to make sure your ESOP pool is not significantly larger than required for your foreseeable hiring needs, as that chunk of equity comes out of your own pocket as a founder. Conversely, you’ll generally want to make sure you’ve set up a big enough pool to attract and retain the talent you’ll need.

2) how much will it cost employees to exercise their options?

The exercise price is the price that an employee must pay to exercise their options and is decided on a case-by-case basis for each employee. The exercise price is often set at the market price of the company’s shares at the time the options are granted (usually determined by reference to the latest completed funding round). Employees then benefit as the value of the company increases from the date they received their options.

3) how long will employees have to exercise their options?

The expiry date of an option is the latest date by which the option holder can exercise that option. This is typically aligned with the expected time frame for the company to find an exit. Typically in Southeast Asia this will be 7-10 years from the date of grant, but of course this depends on your company’s stage and maturity.

The expiry date may change if an employee ceases to work for the company. The most employee-friendly ESOPs do not change the expiry date if any employee leaves. Leavers are therefore not forced into exercising options prior to an exit event. However, some companies prefer to give leavers a shorter time frame, for example up to one year after leaving the company to exercise any vested options. This lowers the company’s administrative burden of keeping track of departed employees who hold options.

4) what is the timetable for the options to vest?

Options almost always vest over a 3 or 4-year period. Vesting incentivises employees to stay with the company throughout the vesting period, in order to be able to exercise all of their options in the future. Generally, if an option holder leaves before the end of the vesting period, he or she will lose their unvested shares.

Our template ESOP rules allow for recipients to have personalised vesting schedules on a case-by-case basis. Shorter vesting periods may be appropriate for employees who have already worked for the company for a significant period of time prior to receiving options.

5) what happens at an exit event?

This is likely to be the part of your ESOP which requires the most thought.

Our template rules provide for single-trigger acceleration on an exit; that is, all unvested options vest on an exit event and can be exercised in full. Single trigger acceleration is the most employee-friendly position and encourages all parties to push for an exit as soon as possible.

However, potential acquirers of your company can be put off by single trigger acceleration, as they often want key employees to stay with the business after the acquisition (and the continued vesting of options encourages that). Some companies therefore prefer double trigger acceleration in order to make their company as attractive an acquisition target as possible.

We find there is a lot of variation in Southeast Asia on this point. Single trigger remains the most common, as compared to the US, where double trigger acceleration is more usual.

The different scenarios are summarised below:

Despite ESOPs being a common feature of many startups in Southeast Asia, their implementation can vary according to founder and investor needs. If you would like to discuss drafting an ESOP for your own startup, you can contact us.