Employee Stock Ownership Plan (ESOPs) are a useful tool to offer potential financial rewards to attract and retain talent by offering them a tangible stake in the company’s growth and success, especially when it follows a convincing story of the company’s vision and goals. In fact, ESOPs have been shown in one study to enhance employee performance by 73%. This article will guide you through the process of creating and implementing an effective ESOPs plan that is aligned with your company’s goals.
Assess the feasibility of creating an ESOPs plan
An ESOP should align with your company’s current financial health and goals, and should ideally be considered after your company has settled on its goals and needs to attract more talent to build towards them, typically during the seed stage of growth. The seed stage is also a more feasible period to implement an ESOPs plan, as it is when your company should have some early revenue and funding rounds ongoing to relieve some financial pressure.
Evaluate potential benefits and drawbacks of releasing an ESOPs plan now. On the one hand, offering stock options can boost employee motivation as it gives them a tangible stake in the company’s success, particularly useful at attracting early joiners. On the flip side, setting up an ESOPs can be time-consuming and costly to set up and manage, on top of all the other responsibilities business owners already have to juggle. ESOPs may add complications to company restructuring later, or during future funding rounds when founders have already been diluted.
Plan around your company’s needs
Tailoring an ESOPs plan to your company’s needs is critical, involving the establishment of clear eligibility criteria, such as an employee’s tenure, the company’s growth stage at the time of their hiring, and their performance in relation to the company’s goals. For instance, eligibility can be tied to achieving specific key performance indicators or milestones, rewarding high-performing employees appropriately. Position seniority can also play a factor, where positions of higher responsibility are also offered more stock options as incentive.
Vesting schedules should also be designed to incentivize long-term commitment, with stock options typically vesting in stages over time—commonly starting with a one-year cliff where a percentage of the offered amount becomes available, followed by additional vesting as the employee continues to contribute. The ESOPs plan should be structured to accommodate future growth by reserving a portion of stock for new hires and strategic talent acquisitions, avoiding unnecessary dilution and ensuring that the plan remains effective as the company expands.
Calculating equity can get confusing if you are new to the process. Fortunately, we have an example here, based on SAAS startup Buffer’s published equity data, that assigns equity multiples based on role, and applies other multipliers to come up with a fair equity amount.
Disclaimer: Values shown here are for reference and may not be up-to-date.
| Job Role | Base Equity Multiple |
| Sales |
0.01 |
| Engineer | 0.5 |
| Product Manager | 0.1 |
| COO | 0.5 |
| Choice | Equity Multiplier |
| Salary focused | 1.0 |
| Equity focused | 1.3 |
| Company Size | Risk Layer Amount* |
| 1-3 | – |
| 3-6 | 1 |
| 7-15 | 2 |
| 16-30 | 4 |
| 31-60 | 10 |
*Risk layer assumes that the larger the company has become, the lower the risk the employee has to bear, which in turn reduces the amount of equity the employee will receive
| Seniority Level | Seniority Amount |
| Senior | 0.1 |
| Lead | 0.2 |
Based on the above factors, the formula to calculate the equity amount here is:
(Role / Risk Layer) * Seniority * Choice Equity Multiplier = % Equity
The resulting equity percentage is then vested over a period of time, to ensure the employee does not take advantage of the system just to gain equity. Example calculations based on roles are as follows, assuming a HK$1 million valuation vested over a two year period.
| Example Equity for a Sales Role @ HK$1 million valuation (1% equity over a 2 year period) | ||
| Vesting Period | Total % Equity Vested | Value of Shares |
| 6-12 months | 0.25% | HK$2,500 |
| 12-18 months | 0.50% | HK$5,000 |
| 18-24 months | 0.75% | HK$7,500 |
| After 24 months | 1.00% | HK$10,000 |
| Example Equity for a COO Role @ HK$1 million valuation (5% equity over a 2 year period) | ||
| Vesting Period | Total % Equity Vested | Value of Shares |
| 6-12 months | 1.25% | HK$12,500 |
| 12-18 months | 2.50% | HK$25,000 |
| 18-24 months | 3.75% | HK$37,500 |
| After 24 months | 5.00% | HK$50,000 |
Do a valuation of your company
In order to implement an ESOPs plan, you need a financial goal for the company to work towards, by performing a valuation to set a fair projected price of your company. There are all sorts of valuation methods that follow all sorts of philosophies on valuations that we will not be able to cover here, but some common valuation methods include:
Cost-to-duplicate approach
This valuation method involves calculating the total cost required to replicate an existing company or its products / services, including research, materials and equipment. While this method provides a fairly objective assessment by focusing on historical costs, it may not fully capture the company’s future potential or intangible assets like brand value, making it less suitable for valuing startups with high growth potential.
Market multiple approach
This method references the valuations of similar existing companies at their current state in the market to provide a valuation. Its simplicity and ability to reflect current market conditions make this a common method among startups, but finding accurately comparable companies can be difficult, raising the potential for mispricing, particularly for startups with previously untested business models.
Discounted Cash Flow
The discounted cash flow method estimates future cash flows for the business and discounts them to their present value using a risk-adjusted rate to calculate a terminal value encompassing its long term potential.
This method is more objective, focusing on the company’s value without being affected by market sentiment when compared to the current valuations of similar companies. It is also more heavily weighted on existing data about your company to project future cash flows and growth rates, making the importance of precise data extremely significant.
Draft the ESOPs document and review it with a legal professional
After putting your plan down on paper, consult with legal and financial experts to navigate the complexities and cover any loopholes in the agreement, ensure the plan meets all of Hong Kong’s legal and tax requirements, and uses clear language to ensure that there are no ambiguities that can be left up to interpretation.
ESOPs in Hong Kong are generally exempt from strict regulatory requirements as long as they are offered to employees, directors, officers, or consultants, and stock options are only taxed as part of salaries tax at the time they are exercised, which we will go into detail next.
Once the document has been properly reviewed, it must be approved by your company’s board of directors and all shareholders before implementation.
Exercising Options Early and Tax Implications
As a general rule, it is advantageous from a tax perspective to exercise the stock option while the stock price or valuation is low, as there will be a smaller difference between the exercise price (also called a strike price) of the security and market value of the shares.
The formula to calculate the total taxable amount (also called total taxable gain) when the shares are granted are as follows:
Total Taxable Gain = (Market value of shares – exercise price of shares) * number of shares
We illustrate the difference in taxable gains when shares are granted early on compared to later as follows:
Eric, an employee at a Hong Kong-based SaaS startup, was granted a right to buy 400 shares of his startup at an exercise price of HK$200 per share after fully vesting for 2 years. At the time of exercise, the startup was valued at HK$20 million. To Eric, choosing to exercise his right now as opposed to years later would greatly affect the taxes he pays when exercising his options. To play out the scenarios:
Early Exercise (HK$20 Million Valuation)
Fair Market Price per Share:
- Company Valuation / Total number of shares = Fair Market Price per Share
- HK$20,000,000 / 40,000 shares = HK$500/share
Taxable Gain:
- Fair Market Price per Share – Exercise Price per Share = Taxable Gain per Share
- HK$500 – HK$200 = HK$300
Total Taxable Gain:
- Taxable Gain per Share * Eric’s number of shares = Total Taxable Gain
- 400 shares × HK$300= HK$120,000
Later Exercise (5 Years Post-Exit, HK$200 Million Valuation)
Fair Market Value per Share:
- Total Valuation / Total number of shares = Fair Market Price per Share
- HK$200,000,000 / 40,000 shares = HK$5,000/share
Taxable Gain:
- Fair Market Price per Share – Exercise Price per Share = Taxable Gain per Share
- HK$5,000 – HK$200 = HK$4,800
Total Taxable Gain:
- 400 shares × HK$4,800 = HK$1,920,000
The numbers used are not an accurate reflection of startups in real life, but they illustrate the difference in salary taxes you would need to pay should you choose to exercise your shares sooner rather than later.
Communicate the plan clearly to your employees
Clearly explain the ESOP to current employees and potential hires, highlighting its benefits and terms. ESOPs are meant to be used in combination with your company’s story and goals, leverage to convince potential hires to buy into your vision and make it their own.
Regularly updating employees on the plan’s performance and any changes made as the plan is adjusted is also important, as the transparency can cultivate trust your employees have towards the company.
Monitor and adjust accordingly
Regularly review the plan’s effectiveness and make the necessary adjustments, accounting for changes in circumstances, for example if growth exceeds your expectations, or market conditions force your company to pivot in a new direction.
Conclusion
ESOPs are a great tool to help foster a culture of ownership among your employees. Implemented with precise timing, proper valuation, and clear execution, ESOPs can give a boost to your company’s growth, attracting and retaining valuable talent to help your company reach its goals.
