Tips to Consider When Setting Up an Employee Share Ownership Plan
A substantial number of companies have recently installed employee share ownership plans (ESOP). Little is known, however, about how such arrangements work.
An ESOP is a share incentive program offered by companies to their employees allowing them to acquire shares in the company. Having an ESOP is an added incentive to productivity and commitment of employees. This is because they play a part in the ownership and the decision making of the company. Further, dividends from an ESOP by a listed company, when registered with the Kenya Revenue Authority, qualify for tax benefits.
1. Types of ESOPs.
The Kenyan legislation governing ESOPs includes the Companies Act 2015, Trustees Act, common law and the Capital Markets Authority Collective Investment Schemes Regulations, 2001 which govern ESOPs in listed companies. Given the undeveloped nature of the ESOP regulations in Kenya, it is submitted that the United Kingdom's statutory schemes regulations provide necessary guidance as to the structure of the main schemes used today.
There are 3 types of schemes in use:
1.1. Profit sharing scheme – this is based upon a trust, which must be established for the purpose. The trustees receive payments from the company and apply these payments in acquiring the ESOP shares. These shares are then 'appropriated' by the trustees to eligible employees in accordance with the trust deed and rules of the scheme.
1.2. Savings-related share option schemes – this is linked to a savings contract. The eligible employees are offered options to subscribe for the ESOP shares with the price payable on exercise being fixed at the date on which the option is granted.
1.3. Share option scheme – participants are granted options to acquire the ESOPs shares. The subscription price is fixed at the date of grant of the option. There may be provisions requiring exercise of the option within strict time limits.
2. Questions to ask before adopting an ESOP.
2.1. Will the succession plan in place get the most out of your company? Having an ESOP will ensure a seamless succession plan since it is attributed to improved productivity, profits and share value. The participating employees in ESOPs give their best to the company since their interests are in line with those of the management and shareholders.
2.2. Is your company big enough? To establish an ESOP, a company is going to need an advocate, a valuation expert and a trustee for the ESOP program. Then, there are continuing compliance and costs for tax returns and annual valuations.
2.3. Are you ready to share your financials? At the very least, you will have to allow the participating employees access to the audited accounts of the company.
3. What are the legal issues arising when dealing with ESOPs
3.1. Capacity of the company to establish the ESOP
A company may only establish an ESOP if it has the corporate power to do so under its memorandum and articles of association. Some provide for a specific power to establish an ESOP, but a more general power to remunerate employees should otherwise suffice. If the objects clause of the memorandum of association needs to be extended to enable the setting up of an ESOP, then the alteration needs to be made by a special resolution in line with the Companies Act 2015.
3.2 Availability of authorized share capital
It is necessary for a company, which adopts an ESOP to have sufficient authorized but unissued share capital for the allotment of shares under the scheme. If the authorized share capital is insufficient, it can be increased by an ordinary resolution of shareholders in accordance with Section 405 of the Companies Act 2015.
3.3. Financial assistance
The Companies Act 2015 permits a company to provide financial assistance for the purchase or subscription of its shares with respect to setting up an ESOP. This financial assistance is available to employees or former employees, spouses, widows, widowers or surviving, or minor children or step-children of any such employees or former employees .
3.4. Trust Deed and Rules of the ESOP
The eligibility of employees, procedure of participating in the scheme, rules of exit, allotment, meetings and other rights and obligations of the parties are usually prescribed by the trust deed and the rules. A clause on the conditions of the vesting of the benefits must be provided for in the trust deed and the rules. It must be clear and notified to the participating employees. This will ensure fairness to employees and not result in instances where an employee feels short changed when they leave.
3.5. Corporate and Tax due diligence.
It is necessary to conduct a corporate and tax due diligence to determine any regulatory issues surrounding the company setting up an ESOP. This will involve the study of the various applicable laws, review of relevant documents and structuring. Only then can the transaction advisors propose an appropriate structure and framework for setting up the ESOP.
3.6. Consequences of termination of employment
For an ESOP by a listed company, the exit procedure is prescribed under the Capital Markets (Collective Investment Schemes) Regulations. With respect to companies that are not listed, the trust deed and the rules prescribe the procedure of the exit of employees from an ESOP upon termination of their employment. The trust deed should expressly provide for leaving of service before and after the vesting of their benefits. Where the employee leaves the company before the vesting period is over, they lose the right to cash in on the shares.
4. What should be in the trust deed and rules of an ESOP?
4.1. Who can participate in the ESOP.
An ESOP will need to make provision in its rules for participation in the scheme. These will include rules on eligibility and participation limits.
4.2. Shares and Share Price
A company may choose to offer its employees the opportunity to acquire shares out of their own resources and it may, for this purpose, create a special class of shares. Such shares are sometimes referred to as employees' shares. Employees' shares may be given any rights which the company chooses.
An ESOP will need to make provision in its rules for the market value and price of its shares, including rules as to the price at which the ESOP shall allot the shares to the employees and the price at which the trustees shall re-purchase units.
4.3 Transfer of Rights
An ESOP will need to make a provision in its rules for the transfer of rights arising from the ownership of shares. These rules will differ depending on the type of scheme in use. The company should therefore set up conditions that must be met before the shares vest in the participating employee.
5. Requirements for an ESOP established by a listed company
The Capital Markets (Collective Investment Schemes) Regulations prescribe some reporting requirements for an ESOP established by a listed company. The listed company is required to disclose any options granted to its employees under the ESOP. Listed companies must seek approval from the Capital Markets Authority before establishing ESOPs and they must upon formation, be registered with the Capital Markets Authority.
Research shows that the presence of an ESOP at a workplace is significantly associated with employee commitment, higher-performing workplaces, better compensation for employees and increase in profits.
Given the potential economic and social benefits of ESOPs, public policy should seek to ensure the improvement of the existing laws governing ESOPs in Kenya to address the various governance matters while considering best practice.
1Section 446 (b) of the Companies Act 2015
2Section 446 (c) of the Companies Act 2015
Disclaimer: This article has been prepared for informational purposes only and is not legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Nothing on this article is intended to guaranty, warranty, or predict the outcome of a particular case and should not be construed as such a guaranty, warranty, or prediction. The authors are not responsible for any actions (or lack thereof) taken as a result of relying on or in any way using information contained in this article and in no event shall be liable for any damages resulting from reliance on or use of this information. Readers should take specific advice from a qualified professional when dealing with specific situations.