Employee equity-based incentive plans seek to remunerate their employees by offering them an opportunity to participate in the share ownership of the company. There are reasons for doing so in general, but what are the key motivations for businesses operating in Singapore and what trends are we seeing? In this article we look at the different types of schemes that are commonly used, regulatory considerations and what key areas to look at when designing an effective plan.
In Singapore, such plans are commonly issued as share options or share awards. In addition, it is also possible to introduce cash-based incentive plans, which are intrinsically linked to the value of the shares of the company.
Historically, employee stock option (or share option) schemes started to gain immense popularity in the United States (US) following a change in its Internal Revenue Code, as it allowed top executives in the US to pay lower taxes on their overall compensation packages. While this may not necessarily be true under the prevailing Singapore tax regulations, it remains a highly effective and relevant instrument for shaping an organisation’s recruitment and retention strategy. The key reasons for this are highlighted below.
How are employee share plans being used in Singapore?
Many companies listed on the Singapore stock exchange offer some form of equity incentives to their executive directors and key employees. However, it is increasingly common for private companies – and in particular startups and early-growth companies – to use such schemes to complement their remuneration packages to attract, retain and motivate employees.
The motivations for using such schemes are clear:
- if utilised properly, it can help to recruit, retain and motivate staff. They are also often used to align the interests of employees, particularly senior executives, with those of shareholders; the aim being to encourage senior executives to consider the best interests of shareholders in their management of the business. As employees become shareholders in the company, it is reasonable to assume that they will be keen for the company to succeed, as a higher valuation of the company’s shares will benefit them monetarily;
- it reduces the costs of employment as companies often balance the offer of equity incentives with a lower base salary. Also, it allows companies to defer a large chunk of the remuneration package to a later date and, significantly, allows early-growth companies to punch above their weight in terms of offering a more attractive salary package to attract and retain talent; and
- share plans are generally not regulated in Singapore and so there is greater flexibility in designing the terms of the share plans to meet the goals and objectives of the organisation. While there are no tax-qualified programmes that result in favourable tax treatment for employees under an employee share plan, employees can defer on paying tax on share option gains for up to five years; but this is only where the share scheme meets all the conditions stipulated under the Qualified Employee Equity-based Remuneration Scheme.
Common types of incentive plans
In many countries, companies may be driven by a desire to fit such schemes within certain confines in order to benefit from tax advantages provided under the relevant tax code or regulations. In Singapore, due to the absence of regulations for non-listed private companies, there is greater flexibility for companies in designing such incentive plans, though it is important to keep in mind that a well-designed incentive plan would allow participants to defer the payment of tax in relation to gains from incentive plans.
The most common types of incentive plans in Singapore are:
- Employee share option plans (ESOP) where participants are granted options to purchase shares in the company at a fixed exercise price, which may be at market value or discounted market value. Share options are usually subject to a vesting schedule where the participant needs to meet certain time-based or performance-based conditions before the incentive shares are vested.
- Share award plans where participants are granted shares at nil cost. Similar to share options, share awards are usually subject to a vesting schedule where the participant needs to meet certain conditions before the incentive shares are vested.
- Phantom share plans where participants are not granted shares in the company, but cash payouts instead. The cash payouts are usually calculated based on either, (i) the value of the “phantom shares” (usually pegged to ordinary shares in the company), or (ii) the appreciation in value of the “phantom shares” from the date of grant to a specified exit event (these are also referred to as share appreciation rights).
How are employee incentive plans regulated in Singapore?
While there is no legislation in Singapore that specifically regulates employee incentive plans, there are several considerations in this regard that the company should bear in mind while designing an incentive plan:
- Securities law – as a general rule, every offer of securities or securities-based derivatives contracts in Singapore must be made in or accompanied by a prospectus or profile statement in respect of such offer. In addition, any prospectus or profile statement must be lodged and registered with the Monetary Authority of Singapore, unless there are applicable exemptions under the Securities and Futures Act 2001 of Singapore (SFA). A company that makes an offer of securities in reliance of an exemption does not need to make any filings. For example, provided that certain conditions are met under the SFA, the offer of share options or share awards will be exempted from the prospectus requirement if the person receiving the offer is an employee or former employee and holds the shares of that entity or its related corporation directly or through a trust.
- Companies Act – for private companies, there is a maximum of 50 shareholders (not including employees or former employees of the company or of its subsidiary) before the company is required to convert into a public company, for which it would be subject to greater regulatory scrutiny. Where a director or chief executive officer of the company receives shares or options under the incentive scheme, he or she is under a general duty to notify the company in writing.
- Personal data protection regulations – under the Personal Data Protection Act 2012 of Singapore, an organisation must obtain consent from the individual before collecting, using or disclosing any personal data of such individual. For participants who are employees of the company, a statutory exception to the consent requirement applies provided that the use of data is reasonable for the purpose of entering into, managing or terminating their employment relationship and the employee is informed of the purposes of such collection, use or disclosure. For non-employee participants of an incentive plan, consent should be sought by the organisation before it collects, uses or discloses any personal data.
- Employment law – where the participant of an employee incentive plan is considered an “employee” of the company pursuant to Employment Act 1968 of Singapore, the company may make deductions from the employee’s salary to pay the exercise price of vested share options, but the employee must consent to the deduction in writing and must be permitted to withdraw the consent at any time. Further, the employer is not permitted to deduct more than 50% of the employee’s salary for this purpose.
Key points to consider when designing a suitable employee incentive share plan
A myriad of factors will contribute to the right choice of incentive plan for a company – one that aligns with the organisation’s culture and values and also meets its overall talent retention and attraction strategy. While it is possible to adopt a standard set of rules which have been used by other organisations, it is important that any company that wishes to introduce an employee incentive plan should have a good understanding of the implications and limitations of the incentive plan rules. These rules are essentially contractual terms between the company and the participants of the incentive plan.
In the absence of any legislation that specifically deals with employee incentive plans in Singapore, there is flexibility for organisations to design the scheme rules. We’ve summarised here the common key considerations, which include:
Objectives of incentive plan
Organisations should consider whether the incentive plan is designed to be a reward (typically for founder employees) or to align interests of employees. For example, if incentives are designed as a reward for work done for the company in the past, it would be counter-intuitive to require the employee to pay an exercise price for the shares.
Participants of incentive plan
Unlike public listed companies, there are no restrictions on which persons may participate in a share scheme for a private company and it is also possible for non-employees (for example, non-executive directors or consultants) to be participants.
There is no requirement for an incentive share plan to be designed for all employees and it is common that there are different plans designed for different groups of participants (for example, a company can have one plan designed for senior management and another plan for valued operational staff).
Type of incentive plan
There are three main types of incentive plans in Singapore, as outlined in more detail above, are:
- Employee share option plans.
- Share award plans.
- Cash-based incentive plans, which are commonly referred to as phantom share plans or share appreciation rights.
Type of shares awarded under the scheme (voting or non-voting shares)
It is possible to create a new class of shares without voting rights so that the employees are not required to vote on most resolutions, other than resolutions that are mandated under the Companies Act 1967 of Singapore (Companies Act). This would help to reduce administrative work for the company if they need to pass resolutions for operational matters.
Size and allocation of the incentive pool, and possible refresh or true-up after capitalisation events
The issuance of employee incentive shares will inevitably dilute the shareholding of the company and while there are no restrictions on the size of the incentive pool, it is usually between 5-20% of the share capital of the company. Once the incentive pool is fully allocated or if new shares in the company are issued, companies may wish to refresh the incentive pool to allow more incentive shares to be issued.
Time-based or performance-based conditions for vesting
A performance condition is a pre-set target for the participant to achieve before the incentive options or awards vest. Performance targets can be tagged to the performance of the individual, department, company or even a group of companies as a whole. Performance conditions can be set on an absolute basis (if targets are met) or on a ratable basis.
These conditions are usually tailored to each specific employee and details are included in the grant letter itself (the letter given to the employee informing him/her on the number and type of incentives granted to him/her). It is common for such schemes to be subject to cliff vesting, where the incentive shares are vested on a specified date instead of vesting gradually over a period of time.
Accelerated vesting or exit events
When the company is close to a sale of its majority interest or listing on a stock exchange, the vesting of outstanding share award or share options is usually either accelerated or allowed to lapse such that there are no outstanding options at the time of sale / listing. It is also fairly common for the incentive plan rules to include drag-along rights so that the majority shareholder(s) are able to facilitate the exit event without resistance from minority employee-shareholders.
When holders of unvested or unexercised incentive awards leave the employment of the company, the company will need to make a decision on how the unvested or unexercised awards will be treated. Often, this is determined by the circumstances of which the employee leaves the company. The company may provide that if employees leave the company in certain events, they will be designated as “bad leavers”. This could include a dismissal from the company, breach of certain post-termination restrictive covenants or breach of confidentiality provisions.
For “good leavers”, the company may allow unvested options or awards to be accelerated or allow the leaver to exercise any vested but unexercised options. For “bad leavers”, the company will typically forfeit any unvested options or awards and will buy back any shares in the company held by the leaver at a discounted value or nominal value (see discussion below).
Malus / clawback provisions
Often, where employees leave the company, the company would not want such employees to remain as a shareholder of the company, especially if they are considered a “bad leaver”. Unfortunately, as private companies do not generally have a market for their shares, companies typically repurchase the incentive shares from the departed employees.
The right to buy back shares from the employees should be expressly stated in the incentive rules as there is no legal right for companies to do so. The right to buy back is also subject to restrictions under the Companies Act – do note that- there is a limit of 20% of a class of shares that may be repurchased by the company within the prescribed period. Further, since there is no readily available market price for shares in a private company (unlike that of a publicly listed company), the company will need to consider and implement a method to calculate the valuation price of shares to be repurchased.
Time to review your company’s employee share incentive plan?
Whether you are preparing to look at the benefits an employee share incentive scheme could bring to your operations in Singapore, or might value reviewing an existing scheme, there are clearly many factors to consider. While there are common approaches, there is no ‘one size fits all’ and any plan needs to be carefully aligned with your organisation’s culture and values, as well as its overall talent retention and attraction strategy.
If any of the points raised in this article have generated further questions and you’d like to discuss, please contact Vincent Tan.
Vincent is a corporate lawyer specialising in mergers and acquisitions, cross border investments, and other general corporate and commercial matters.