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5 key questions to consider when setting up an ESOP

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.

how to calculate your ESOP pool shares

This short guide demonstrates how founders should calculate the number of options to include in their ESOP pool.

For the purposes of this example we have assumed that the founders are setting up a customary 10% ESOP pool (check out our guide 5 key questions when setting up an ESOP for a more detailed discussion on the appropriate size of your ESOP).

example

In almost all cases you should calculate the size of your ESOP pool on a fully diluted basis. i.e. the ESOP should be equal to 10% of all shares and options on issue (including the ESOP). Looking at a company with 1,000,000 shares on issue:

tool

If you are experiencing some arithmetic fatigue, we have you covered. Available for free download here is a spreadsheet tool that incorporates the above formula. All you need to do is plug in your total number of shares and options on issue, your ESOP pool size as a percentage, and the tool will generate the relevant number of ESOP pool shares.

Excel version

how to set up an ESOP: a step-by-step guide

(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:

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.

what happens to an employee’s share options when a company exits?

Your employer has granted you stock options as part of your remuneration package. But what does this mean when your company is sold or listed (called a liquidity event), and more importantly – when do you get your money?

In this ‘Tricky Clauses’ guide we discuss how ESOPs work for employees of startups in Southeast Asia when a liquidity event occurs.

Other installments in our Tricky Clauses series:

a quick recap on ESOPs

Under an ESOP, an employee receives options over shares in a company. Those options typically vest over a period of 3-4 years.

When an option has vested, this means the employee can exercise it and purchase a share in the company. Often, employees wait for a liquidity event before exercising vested options. This is because the employee has to pay an exercise price to exercise options, and may also be liable for tax. If an employee waits until a liquidity event occurs before exercising options, they can sell the shares in that liquidity event and (ideally) get some upside after paying their exercise price and tax bill.

what is a liquidity event?

A Iiquidity event is a transaction that enables all or a substantial portion of the company’s shares to be sold. This is typically an exit transaction (i.e. a sale of the company or its assets in a private transaction) or a listing on a stock exchange.

what does a liquidity event usually mean for an employee holding options?

In Southeast Asia, employee share options often fully accelerate on a liquidity event. This means that, on an exit or a listing, all unvested options immediately vest, and employees can exercise all of their options and receive shares in the company.

Employees can then participate in that liquidity event, by selling their shares to the buyer of the company or on the stock exchange, or by receiving profits out of a sale of the company’s assets.

Under this scenario, called single trigger acceleration, employees get the chance to exercise all of their options and cash in the resulting shares, no matter how long they have been with the company. As you can see, this is an employee-friendly scenario.

what other scenarios are out there?

Another scenario you sometimes see is called ‘double trigger acceleration’

In some cases, two events need to occur before an employee gets to exercise all of their options:

  • the company has a liquidity event, and
  • the company or acquirer terminates the employee in close proximity to the liquidity event – (e.g. within a year).

This means that if an acquirer retains an employee, she or he can only exercise any options that have already vested, and needs to keep working at the company until the end of their vesting period before they can exercise the rest of their options. Only employees who are retrenched or made redundant soon after the liquidity event can exercise all of their unvested options (this is the second “trigger” in action).

For those employees who are retained, it is common for the acquirer to trade options in the target company for options over shares in the acquirer. This can be good for employees if the acquirer is a listed company, as it creates liquidity for the employees as options vest.

Double trigger acceleration is the most common position in Silicon Valley deals. If you’re an employee, this means you don’t automatically get to cash in when the company exits, unless the acquirer also lets you go shortly after the acquisition.

From the company’s perspective, double trigger acceleration can make the company more attractive to potential acquirers, as those acquirers will have some comfort that employees are less likely to leave soon after an acquisition.

(Confused with startup jargon? Head over to our startup glossary.)

what can companies and employees expect in the future?

Over the past year or so, we’ve seen more VC deals in Singapore adopt double-trigger acceleration, and we think we will see more of this as deals generally head towards more Silicon Valley-style terms.

Want to discuss your ESOP plan or thinking of putting one in place? Get in touch with one of our startup lawyers.

other ESOP resources for you to explore

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explore our case studies

X0PA.AI

about X0PA.AI

Singapore-based X0PA.AI is a SaaS talent hiring and recruitment platform that uses AI and data science to match applicants to roles, as well as predict issues such as attrition, loyalty and performance.

CEO Nina Suri has scaled the team over three years to twenty-five employees, located across Singapore, India, and the UK, with plans to start in the UAE.

X0PA recently implemented an employee share option plan (ESOP) and Nina shared her experience.

why implement an ESOP

“Having had over twenty years of entrepreneurship, I knew I wanted to build a culture of ownership and inclusivity, and ensure that our team felt involved and satisfied”, says Nina.

 “An ESOP is one way that our employees can feel like they’re a part of growing something – that our success is their success”, says Nina.

putting the ESOP in place

The company originally drafted some ESOP paperwork when they first incorporated, but as they grew, X0PA’s company secretary recommended that it be replaced with something more robust and market standard.

“We learned that the ESOP needed major amendments in order to be more in line with what is typically seen in the market in Singapore, and reflect what investors are likely to expect”, said Nina.

Nina reached out Kindrik Partners after the firm was recommended to them by their company secretary. XOPA worked with Sarah Yen in Kindrik Partners’s Singapore office, who was able to create the right framework for the startup.

“We were looking for a firm who advised a lot of startups in Southeast Asia. Sarah took the time to explain and really make sure that we understood the mechanics of how the ESOP operated. This made it easier for us to communicate that to our employees.”

“It’s important when putting together an ESOP to consider several different factors”, says Sarah. “What works for the company, what is standard in the market to attract quality talent, and what your investors and most importantly a future potential buyer might expect to see.” 

about the ESOP

A X0PA employee is invited to participate in the ESOP once they have been with the team for twelve months, and if they’re considered a ‘high performer’.

“At the moment we have a rockstar team, and 100% of the people who we have hired have been invited to join”, says Nina.

“In my previous venture I also felt strongly about letting my employees be directly involved – but I gave them straight equity. It was a more traditional business with a partnership model.”

“This time, an ESOP seemed more appropriate – it was a more scalable model and more appropriate for the type of company we wanted to build.”

X0PA’s management team put aside 10% of the company’s equity towards the ESOP, with the expectation that this allocation would last at least five years. They set the exercise price by the valuation of the company at the time of allocation.

Allocations were not standardised per employee but were allocated according to the contribution and importance’ of the employee’s role in the organisation, according to Nina.

The X0PA team also included an acceleration clause in the ESOP – if the company exits before the vesting period, their employee’s options fully vest.

advice for other founders

“We weren’t familiar with the nitty gritty of putting in place an ESOP – it was a new experience for us”, says Nina.

“My advice would be to go with a lawyer who is experienced with startups and ESOPs, so you don’t have to go through the complications that we went through as we started to scale”, she says.

Nina also stressed that it was important to familiarise yourself with the mechanics of your startup’s ESOP so that management could communicate with staff effectively about how it worked.

Nina also had some tips about how to communicate with a team when implementing an ESOP.

“We kept it very simple for our staff. We broke down into the main points – what is the ESOP, what does it mean for them, what do they get, how much do they get.  We didn’t want to get them worked up about the legal language.”

Nina also made sure that she sent each team member an individual email after the scheme was introduced to the company, confirming what the ESOP meant, how that individual’s options vested, and what would happen to their options in different scenarios.

“You need to make sure your team understands what the ESOP is. If you’re giving them something, and they don’t appreciate it, and then what’s the point? It’s best to spell it out and make sure that everyone understands – then you’re all working towards a common purpose.”

what’s next for X0PA?

“We’re starting to move from startup to scale up now. We’re experiencing massive acceleration and growth, with several Government departments, enterprises, polytechnics and universities as clients”, says Nina.

“Our product is ready, and strong, and we’re ready to grow and help our clients with their digital transformation. We are focused on growth both from increasing market share in the markets we operate in as well as market expansion point of view.”

[Note: The firm’s name was changed to Kindrik Partners in July 2020 and references to the firm’s previous name have been updated.]

Explore our other case studies here, or access our full library of ESOP guides and templates via our resources section.

pixibo

Singapore-based Pixibo provides personalised size and fit recommendations in real time for online retailers and their customers. The fashion-tech startup worked with Kindrik Partners on their recent series A raise.

We spoke to founder and CEO Rohit Kumar on Pixibo, the capital raising journey, and working with Kindrik Partners.

pixibo’s story

Rohit is an ex-Googler with experience across Europe and India, before heading to Singapore to head up operations for e-commerce advertising company Sociomantic. Between 2013 and early 2016 he launched and managed all of Sociomantic’s APAC operations and was part of the team that sold the business to dunnhumby, a Tesco company.

It was at Sociomantic that Rohit identified an issue plaguing fashion e-commerce sites. People were browsing clothes online, but very few of those visits converted into sales. “The average conversion rate is 1.5%”, says Rohit.

Pixibo’s technology was formally launched in 2018, after a few years in development.  The platform makes real-time size recommendations, personalised for every shopper and for every brand and SKU. For a retailer this boosts conversion rates, reduces return rate and improves customer satisfaction.  Its size recommendation engine is entirely white labelled and  can be natively integrated into online stores.

 “In online shopping, there’s a lot of pain points, from finding something you like, to working out which size is correct for you,” says Rohit.

“Decision fatigue can come in, reducing sales and resulting in increased return rates. The Pixibo platform works to reduce the friction felt by the consumer and the retailer.”

working with kindrik partners

“I was educating myself about series A rounds when I came across Kindrik Partners’s content online,” Rohit says.

“It was my first time doing an institutional round so I was spending more time online trying to get my head around the legal terminology and the types of things that show up. Drag alongs, tag alongs, liquidation preference clauses. There’s a lot to understand.”

(confused? see our startup glossary )

“It looked like Kindrik Partners were the best lawyers for startups,” says Rohit.

“It was clear from the content that was available online that it was their area of expertise. When I eventually needed to bring in a lawyer to help with my round, I reached out.”

on the series A round

Pixibo already had several angel investors prior to their series A round in 2018, but the startup did not have any VCs on board, so the experience was new.

 “We had VPs from Google who invested at an early stage, as well as strong private angel investors. But this was the first institutional round, and it felt very different.”

A big learning was how much longer the process took. “I thought you’d just go out to market, pitch, and then get them to sign. I eventually came to understand the level of process that institutional investors require, and how this stretches out the timeline.”

“There’s a great level of detail required. From investor interest to the term sheet to drafting the shareholder’s agreement, share subscription agreement and the whole nine yards, to signing, to getting money in the bank… it can take a long time!”

Fortunately, runway was less of a concern for Pixibo. “We weren’t in a rush. We had revenue, so there was no immediate need to get funding in”, says Rohit. “We already had a recurring revenue from our licence fees we were charging. That started conversations for us with investors, too.”

working with kindrik partners

Rohit found working with Kindrik Partners and partner Lee Bagshaw provided a lot of value during the capital raising process.

“Working with Lee was great. He was very responsive to my requests and concerns and was always happy to get on a call if need be to walk through things with me.”

Kindrik Partners’s experience in capital raising in Southeast Asia was also an asset to Pixibo.

“As a first time founder, sometimes you’re like wait, hang on, why is that in there? Lee was invaluable in these situations. He understood what terms were negotiable and what terms weren’t, and was instrumental during all of the back and forth with investors.”

tips for founders embarking on their A round

Rohit has a few tips for those entrepreneurs who are considering going out to do their series A round.

  • start out 6 -8 months before you need the capital: especially if it’s your first institutional round (it gets easier with a follow-on round, because you’ll have existing investors to help you get your foot in the door).
  • consider a rolling close: since you’re looking for investors who are the right fit in a long-term partnership, having a rolling close allowed Pixibo to get the money in the bank from the investors who were committed, while continuing to find the perfect fit to close out our round.
  • beware the temptation to think that any money will do: in the beginning, the temptation is to look for anyone with a cheque book, but then you get smarter. Find the VC’s thesis and their sweet spot, and get smarter at looking at their portfolio to see if you fit in. Who will be interested in your story?
  • don’t raise too soon: Traction is important. Wait until you’re in a strong position to raise, if you can. In our case, as we’re B2B, we had clear proof points that our product works, solves a real problem for online retailers and that they are willing to pay us for it. Investors will want to see that you have put in the hard work and that capital will accelerate growth.
  • have a plan for the money. You have to articulate why you need capital now, and how it will help your business.

what’s to come for pixibo

The future is bright for Pixibo, and Rohit is looking ahead to expand into new markets. “The most exciting thing about us is that we’re location agnostic. The problems retailers have in Singapore are the same ones that they have in Sydney. The opportunity is massive.”

[Note: The firm’s name was changed to Kindrik Partners in July 2020 and references to the firm’s previous name have been updated.]

99co-simmonds-stewart-client

99.co

Singapore based property startup 99.co likes a challenge. Dominated by well funded regional players, there would be easier sectors to disrupt than online property. However 99.co is fighting hard with a unique proposition. The company has raised two rounds of funding since incorporation and is backed by high-profile investors including Sequoia Capital and Facebook co-founder, Eduardo Saverin.

Founder and CEO, Darius Cheung, talked to us about the company’s progress, its most recent capital raising transaction in 2015, and how they have found working with Kindrik Partners.

the 99.co story

Darius is one of Singapore’s celebrated young tech entrepreneurs having sold mobile security startup tenCube to McAfee in 2010. This was a decent sized exit for a Singapore tech startup at the time. With the current hot funding environment and massive interest in mobile disruptive technologies in Southeast Asia, Darius is now looking to build a company for an even larger exit.

Not surprisingly, given the city state’s rapid growth, Singaporeans have always had a real interest in property. So 99.co is playing in a compelling space. Singapore has over 30,000 property agents many of which use online real estate platforms such as 99.co. The company recently set up an Indonesian website and plan to get going in Malaysia and Thailand further down the line.

99.co differentiates itself from larger competitors by promising a more intuitive search experience, where the rankings for listings are influenced by the quality of the published content. The site, for example, could favour listings with more photos or with value add information such as commute times or local amenities. This contrasts with the traditional model where the level of fees paid typically pushes classifieds higher. Darius believes that users will increasingly seek this kind of consumer friendly experience.

99.co charges agents a basic subscription fee to list their properties. The company has, however, recently launched a new product called 99PRO – a subscription model where agents can unlock additional features like interactive map searches and new data.

challenges

Darius agrees that the competition is tough to crack in Singapore and the region, given the dominant players. Content is king – the number of listings is fundamental to the success of the business. Bridging the gap, and chasing the platforms that have the majority market share, requires innovative offerings. Plus it’s a crowded market. Aside from other startups trying to challenge those established players, print media still retains a surprisingly sizeable chunk of the market.

The nature of 99.co’s subscription model means the company will need to add alternative revenue streams over time.

Finally, talent acquisition in Singapore and building the 99.co team has been difficult given the number of other startups also hiring sought-after developers.

working with kindrik partners

Lee Bagshaw was introduced to Darius by one of 99.co’s investors. Lee has helped the company through each of its financing transactions. Most recently in 2015, Lee, supported by Chris Wilson, advised on the company’s series B transaction led by Sequoia and Saverin.

Darius’ previous view on lawyers had been that they were expensive and it was not always easy to see their value. He describes working with Lee as a breath of fresh air. Whether by email, on the phone, by WhatsApp or even in the passenger seat of Darius’ car, Lee’s advice was always simple to understand, but with real value add.

Darius was impressed with Kindrik Partners’s knowledge of VC financing deals in Southeast Asia. He says Lee and the team were also very fast, generally turning documents around in under 24 hours. Darius believes that, by working for a tech focussed firm, the Kindrik Partners lawyers have a greater connection with startup founders, combined with unique experience. Throughout the negotiations, Darius found that even if the company could not secure the best outcome on all points, Lee and Chris ensured that he understood clearly the implications, so he could quickly move on.

summing up

99.co are operating in an exciting space in Southeast Asia. Real estate tech companies globally have grown rapidly, achieving some astonishing valuations.

Sequoia’s and Saverin’s backing shows that notable investors are looking carefully at this space in Southeast Asia, particularly for platforms that are distinguishable from the others.

Kindrik Partners will be closely watching 99.co continue its growth to become a significant online property player in Southeast Asia.

Explore 99.co.

[Note: The firm’s name was changed to Kindrik Partners in July 2020 and references to the firm’s previous name have been updated.]

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