Employee Stock Option Plan

November 21, 2018

Corporations need to consider the benefits of an Employee Stock Option Plan. An Employee Stock Option Plan (ESOP) can strengthen employee engagement and encourage employee retention. It can also be an alternate method of providing compensation to valued employees.

With an Employee Stock Option Plan, the company would offer to one or more employees the option to purchase a specified number of shares in the company at an exercise price. The exercise price can be the fair market value of the shares, but is typically a discounted price from the fair market value. The options can be vested or unvested, meaning non-exercisable until a future date. Participation in the program is optional, and the offer will likely set out the final expiry date for exercising the option.

The company may wish to set an option vesting period over a certain amount of weeks, months or years. Alternatively, the company may wish to tie vesting to certain achievements of the employee or company. In this way, a company can motivate employees to help meet certain corporate goals.

To create a stock option plan, the company amends its articles to create a separate class of shares tailored for the stock option plan. One key challenge of developing an ESOP is ensuring the Board still has a certain degree of control over corporate affairs, while allowing employees to enjoy active participation in the company. The company may require that employees enter into a Pooling Agreement relating to mandatory voting in support of, for example, shareholder resolutions with two-thirds approval. The company may also wish to have employees execute a waiver of dissenting rights and a termination clause in the event an employee does not honour his or her employment agreement regarding, for example confidentiality, non-solicitation.

There are other helpful provisions for ensuring predictability and control over the corporation, including the implementation of an acceleration and/or drag along provision. With an acceleration clause, vested and unvested options can accelerate and/or terminate in the event an offer is received to purchase the business, or an initial public offering. A drag along provision could provide that, in the event of a sale of the business that receives the consent of, for example, two-thirds of the shareholders, the remaining shareholders are “dragged” into executing the appropriate documents along with the majority.

There are many other important considerations when creating an Employee Stock Option Plan. For example, the company may wish to have the right of first refusal on the shares issued pursuant to options. In addition, the company can implement a prohibition on a transfer of shares to any third party by the employee. The company could also implement a Put/Call provision, whereby participants may cause the Company to buy his or her shares, and the Company may require a participant to sell his or her shares.

When the option holder sells, the realizable value is the amount by which the value of the shares exceeds the exercise price on the date the option was exercised. There are tax considerations with an ESOP, which are beyond the scope of this article. However, you should consult with your accountant regarding the employee/employer tax implications of participation in an ESOP.
There are a number of challenges and pitfalls to avoid when crafting an appropriate ESOP. You should consult with your corporate lawyer to help you prepare a package that suit your company’s needs.

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