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An Employee Share Ownership Plan (ESOP) using call options, can be an effective way to attract, engage and incentivise key employees by offering stock options rather than cash incentives or high salaries.

Employee share schemes using call options

We've all heard success stories of employees doing very well for themselves by acquiring stock options in early stage companies, and Employee Share Ownership Plans are gaining in popularity across NZ and Australia.

While typically most common in startups and tech companies, employee share plans using call options are becoming increasingly common for larger and more established companies. Any company wanting to create an ownership mentality and a greater sense of employee engagement can benefit from establishing an ESOP, no matter the age or stage.

What are call option plans?

An options plan is one type of ESOP scheme and is a method of granting equity (or ownership) to an employee over a period of time. The employee initially receives call options to purchase shares at a later stage. Options plans are often favoured by early-stage growth companies, where the company doesn’t have the cashflow to pay large salaries, employees may not be able to afford to purchase shares, or the future of the company is still hard to determine.

Share options are traditionally earned through longevity in the company or performance milestones. They will normally defer the tax payable by the employee until the point the options convert to shares. Eventual tax implications for the employee can be aligned with the employee’s opportunity to sell the shares when it will be easier to fund any tax payment. Early stage investors will often request that an options plan is implemented prior to their investment, as they recognise their potential value for the company. More mature companies can also benefit from options plans, particularly when they are heading toward a sale or liquidity event.

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What is the process for call options?

Once call options vest (are made available), either at performance-based or time-based milestones or a combination of both, the employee can choose to exercise their option (buy the shares) at a pre-agreed price. The rules and conditions for an options plan offer will be set out in an Offer Letter or Plan Rules. If options don’t vest for any reason, then they lapse and can be recycled into the company’s option pool to be allocated to other staff.

The nature of options plans means that they can provide an appealing way to offer competitive remuneration without immediately drawing cash from the business. As such, options plans can be an ideal option for startups and private companies in the growth stage.

Setting up a call option ESOP

The first thing to do when setting up a call option plan is to decide which structure is right for the business. Companies should discuss this with their professional advisors such as lawyers or accountants to ensure the best parameters are selected to achieve the desired outcome.

Once an approach and criteria are decided, the options plan pool is allocated. This typically sits around 10% of total shares in the company. Employees are advised on their call option plan details, and using a system like Orchestra’s ESOP tool, they can access their information and oversee their progress towards ownership.

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DISCLAIMER: This article is for informational purposes only, and contains general information only. Orchestra is not, by means of this information, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This information is not intended as a recommendation, offer or solicitation for the purchase or sale of any options or shares.