ESOP/PSOP
TL;DR
- With an ESOP, participants will become actual shareholders of the company and be entitled to financial benefits and voting rights.
- With a PSOP, participants are granted contractual rights to participate financially in the company's exit as if they were shareholders.
- Best practice is to set up an ESOP or a PSOP with the first financing round.
ESOP
ESOP stands for Employee Stock Option Plan. Employees become co-owners of the company they work for. They are usually given shares at below market value (or even for free).
This increases employee motivation and accountability. As shareholders, employees are given the right to participate in shareholder meetings and vote on important strategic issues.
When employee shares are granted, the difference between the exercise price and the market value is taxable income. If this difference is large, it can have a significant impact on the employee's tax burden without the employee having received any cash. On the other hand, the shareholder generally receives a tax-free capital gain if they sell the shares at a higher value than the purchase price.
Establishing and administering an ESOP is more complex because the legal foundation must be laid before an ESOP can be implemented. In particular, a (new) shareholders' agreement is required and the company will usually create conditional share capital.
PSOP
Under a PSOP, employees receive phantom shares. This gives them a virtual stake in the company, but without shareholder rights (e.g. voting rights).
The financial rewards are linked to the appreciation of the company's stock price. The financial benefits of a shareholder are replicated as much as possible on a contractual basis.
The underlying PSOP specifies the events upon which the phantom shareholders will receive a payout. The desired scenario is usually the sale of the company and thus the exit of the existing shareholders. Besides this, it can also be stipulated that the phantom shareholders are entitled to receive a payout if the company pays dividends to the shareholders. This means that no distributions will be made to the phantom shareholders unless there is sufficient liquidity.
The fact that no real shares need to be issued and that the phantom shareholders have no right to participate in the shareholders' meeting makes it easier to set up and administer than an ESOP.
With a PSOP, participating employees are motivated to work on the long-term strategic objectives of the company as it is mainly based on share value increase. However, since the employee does not become a co-owner of the company, the retention effect is weaker than with an ESOP.
The tax burden for the employee is higher compared to the ESOP.
This is possible from the moment the company is incorporated and as long as the company exists.
Best practices
Timing: Set up such a plan upon the first Financing round. This will often be asked by investors to properly incentivize (key) employees.
You will need the following documents:
- A plan setting up
- Rules on the administration of the plan
- A vesting schedule
- Rules on the exercise of the granted (phantom) options
- Rules governing the granted options
- An allocation agreement that determines for each participant the number of (phantom) options granted and some possible specific rules that apply only to them.
Best practices
Pool: The option pool represents 10% of the company's share capital.
Administration: The board of directors is in charge of the administration of the plan.
Vesting: The following vesting schedule is in place:
Cliff: 1 year
Vesting period: Between 3 and 5 years
Vesting intervals: 3 months