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:

no acceleration	None of the unvested options vest on an exit event, and any unvested options expire. Option holders can only exercise options which have vested.
partial acceleration	A set percentage of the unvested options vest on an exit event. The remaining options continue to vest in accordance with the vesting schedule. This can be important to a buyer where employees remain employed by the surviving entity, so that they continue to work for the business and earn their options. However, it can be less appealing to employees, who will lose unvested options even if they are terminated without cause.
double trigger acceleration	A set percentage of the unvested options vest on an exit event. The remaining options vest on a second trigger, e.g. the employee being terminated (or resigns with good reason) in connection with, and within a certain time after, the exit event. That way, if the second trigger event does not occur, the employee must stay with the company in order to earn their remaining unvested shares. However, if a buyer does not choose to keep an employee after an exit, the employee is not penalised for this. In Southeast Asia, we do not see double trigger acceleration very often but expect that to change as some of the larger tech companies adopt Silicon Valley practices.

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.

(revised 11 February 2020)

introduction

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

To make it easy, we’ve put together this guide to help you through the process of adopting your ESOP, setting up your option pool, and granting options.

Related guides you might also find useful:

• 5 key commercial decisions you need to make about your ESOP before you start (a good precursor to this guide)
• Tricky clauses: what happens to an employee’s share options when a company exits?
• Tricky clauses: what is founder vesting?

Ok, let’s get started. Here are the steps that you need to take in order to set up an ESOP in your startup. This is based on industry standard for startups that have a headco and employees based in Singapore – your mileage may vary for companies domiciled in other countries.

1. draft the ESOP rules

Your ESOP rules set out the terms that apply to all options granted under the plan, including the process for granting options, how and when employees can exercise their options, and what happens to the options on an exit event, or if an employee leaves.

If you’re using our ESOP, that document will include the following schedules:

• schedule 1 – a grant letter setting out the terms of the options you want to grant to recipients
• schedule 2 – the form of the exercise notice to be delivered to the company when an option holder wants to exercise their vested options
• schedule 3 – an option certificate which records the number of options, exercise price and vesting provisions.

2. approve the rules and the option pool

Once you are happy with your ESOP rules, your directors and shareholders will need to sign some corporate approval documents to adopt the ESOP rules and set up your option pool.

For Singapore companies, these resolutions will typically be prepared by your corporate secretary. If your company is based elsewhere in Southeast Asia, we recommend confirming this step with a local law firm.

board and shareholder approval

You should ask your corporate secretary to prepare a set of directors’ resolutions in writing for the directors of your company to sign and a similar set of shareholders’ resolutions in writing for your existing shareholders to sign. The resolutions should include the following:

• approval of the ESOP rules
• the total number of options in the ESOP pool.
• authorisation for the board to grant options to recipients of their choosing (up to the number available in the ESOP pool), and
• authorization to issue shares on any exercise of the options

shareholder waivers and consents

Your constitution and shareholders’ agreement (if you have one) may include pre-emptive rights on the issue of new shares.

If this is the case, those shareholders with pre-emptive rights will need to sign a waiver in respect of any options granted under the ESOP (and any shares issued on the exercise of those options). If required, you should ask your corporate secretary to prepare this shareholders’ waiver as well.

Finally, you should also check your existing constitution and shareholders’ agreement (if any) for specific consents required from any shareholder in order to issue shares, grant options, or establish an ESOP. For instance, if you have been through an external funding round, your investor may have a veto right over the issue of any new shares or options. If that is the case, you will need that party’s written consent to grant options and issue shares under the ESOP.

Now you are ready to begin granting options.

3. grant your options

Here’s what you need to do to grant options to selected recipients.

prepare your directors’ resolutions

Each time you want to grant options, you should ask your corporate secretary to prepare a new set of directors’ resolutions in writing, approving the grant of options to a specific recipient (or list of recipients).

send each recipient their grant letter

Send each recipient:

• a completed & signed grant letter (that includes the number of options granted, the exercise price, and the vesting schedule). Our template ESOP rules include a template letter of grant at (see schedule 1) which should form the base of each grant letter.
• a copy of the ESOP rules attached (note: the schedules attached to the ESOP rules themselves should be left blank in all cases.)

If the recipient accepts the offer, they should counter-sign the letter of grant and return it to you.

issue the option certificate

Once you have received the countersigned letter, you can issue them their option certificate.

In our ESOP rules template, you can find the option certificate form in schedule 3 (again that schedule should be left blank and a separate option certificate provided to the recipient – i.e. you need to create a fresh, separate Word doc).

update your option register

Internally, you should also be keeping an option register, which is a record of all the options the company has granted, the vesting schedules, expiry dates, and exercise dates.

how can an option holder exercise their options?

If an option holder wants to exercise their options, the first thing to do is check whether those options have vested in accordance with the option holder’s vesting schedule and have not expired under the ESOP rules.

If the options have vested, the option holder should deliver an exercise notice to the company. Our template rules include a template exercise notice that can be used for this. If you’re using our template rules, the process for exercising options is set out in Rule 5.3.

summing up

Setting up an ESOP is not too difficult once you have a set of ESOP rules that you are happy with. In most cases, your company secretary will be able to prepare all the necessary resolutions pretty efficiently.