Blog · Startups
ESOP - Employee Stock Option Plan
The ESOP is an excellent tool, not only to motivate employees but also to retain and incentivise them to stay with the company in the long term. As an additional benefit, the employee stock option plan also allows the company to attract and incentivise talents without draining the much-needed liquidity.
After the initial overview of the different forms of employee participation and a closer look at the allocation key options, this article will focus on employee participation plans (ESOPs) in Switzerland.
Employee Stock Option Plan (ESOP)
Liquidity is often tight in the startup phase of any company. With employee shares, employees may be paid a lower (or no) fixed salary in cash, and the difference to the market salary is compensated by issuing options or shares. This is particularly interesting if someone brings in benefits that would otherwise be difficult to obtain or very expensive.
We will first look at how an ESOP is set-up before we find out how it can help to motivate and retain talent.
In the next blog post of this series, we will dive deeper to understand why shareholder approval is needed to set up an ESOP, what it means when employees become shareholders and why it might make sense to grant options first instead of issuing shares directly.
The setup of an ESOP in Switzerland
With share participation plans, selected employees get a stake in the company’s share capital. Participation can be done (i) directly by transferring shares or (ii) indirectly by granting options to receive shares at a later date.
The ESOP consists of two core documents:
- Plan – here all details regarding the employee participation are unilaterally defined by the company;
- Allocation agreement – this allocates the options or shares to the participant and in return, the participant agrees to be bound by the plan (and to pay a price for the options / shares if provided for in the plan).
The core document of an ESOP is the**‘plan’**, which is drawn up by the board of directors. This plan sets out all important aspects with a binding effect for the participants. Usually, the employees (participants) are not involved in this process.
Before options or shares are allocated to a participant, the respective participants have to sign an allocation agreement, in which they agree to be bound by the provisions of the plan and by which the options or shares are allocated to the respective participants.
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ESOP Vesting: Retain and motivate talent
The most important asset of a startup is often the employees. It is therefore important to keep them motivated and retain great talent for as long as possible. An ESOP should therefore, on the one hand, attract new talents and motivate the team and on the other hand ensure that the team members are incentivesed to stay with the company for as long as possible. This is usually done by restricting the transferability of employee shares for a certain period of time and with a so-called vesting schedule (reverse vesting).
If an employee leaves the company before the end of this vesting period, the unvested shares must be returned (e.g. at nominal value) or the unvested options expire. All vested shares may be retained or the options may be exercised (exchanged for shares). If you want to avoid that former employees can remain shareholders, you should include a purchase option in the shareholder agreement.
With an ESOP in place, the company will not only be owned by the founders but also by the employees. The participation aims to ensure that participating employees benefit monetarily from a potential exit, thereby making the company more attractive as an employer, retaining talent, and increasing the motivation of the employees.
Caveats
An effective employee participation program is nowadays virtually mandatory for all startups. If such a scheme is not yet in place, investors usually demand it because it helps toretain and motivate employees (the driving force behind the company’s success) in thelong term.
The ESOP contains two core documents:
- Plan – here all details regarding the employee participation are unilaterally defined by the company;
- Allocation agreement – this allocates the options or shares to the participant and in return, the participant agrees to be bound by the plan (and to pay a price for the options / shares if provided for in the plan).
To retain great talent for as long as possible, any well-drafted ESOP also contains a vesting schedule. Under such a vesting schedule, participants have to earn their right to the shares over time to ensure that the team members are incentivized to stay with the company for as long as possible.
If you’re considering setting up an ESOP for your company, or need advice on how to make the most of your employee ownership plans, we’re here to help. Book a free call with our experts today to discuss your needs and how we can help you create an effective ESOP tailored to your company’s goals.
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