From Engineering to Mastering: Employee Stock Option Plans for Technology Firms
Prevalently used by the firms located in USA, employee stock option plans made its debut in 1950’s in pharmaceutical giant Pfizer. It has become more popular in 1980’s and used more commonly for attracting talent.
Employee stock options are more common in public companies. Nevertheless, such options may also be used by SMES. Various stock option plans may be initiated in accordance with the needs of the employer (or company). Employee stock options plans may be designated to the senior and employees and/or other employees as well.
The aim of employee stock option plans is to increase the motivation of the current and prospective employees and attracting talent to the company. If the company succeeds financially, the employee shareholders would also enjoy this success as a shareholder and/or as a stakeholder.
Most of the stock option plans that are in use are designated for public companies. Public companies issue stocks that are exchanged in the market and thus an employee may sell stocks in the stock market. However, for non-public companies, employee cannot trade the shares in stock exchange; the basis for stock option plans for non-public companies is generally dividends and various premiums.
The following plans are the most popular stock option plans for employees:
- Employee Stock Purchase Plans: In this plan, an employee purchases the shares of the company at a discounted price. This happens either by periodical cuts to the employee’s payroll or through direct purchase. The shares in question are bought by the company from the stock exchange and sold to the employee.
- Stock Option Plans: In this plan, an employee may purchase shares of the company after a vesting period for a predetermined price or for free of charge.
- Restricted Stock Units: In this plan, shares are transferred to an employee through a vesting plan and a distribution schedule after achieving required performance criteria or work as an employee in pre-determined period.
- Phantom Shares: In this plan, the company does not transfer shares to the employee. The company may pay premiums and other incentives to the employee upon achieving a performance criteria or work as an employee in pre-determined period. Employee, in this plan, does not become a shareholder after accepting the plan and is not entitled to rights and privileges granted by relevant legislation and articles of association of the company.
Turkish Law Perspective
Turkish Code of Obligations dated 04.02.2011 numbered 6098, permits the distribution of additional benefits to employees through dividends and share transfers. However, distribution of dividends and share transfers shall be conducted in accordance with the provisions of Turkish Commercial Code (“TCC”) dated 13.01.2011 and numbered 6012 and Capital Markets Law dated 06.12.2012 and numbered 6362 for the public companies. The company may use the following methods to issue shares and distribute such shares in accordance with the abovementioned plans:
- Company may increase its share capital and directly issue new shares to the employees. Pre-emptive rights of the existing shareholders may be restricted for the issuance in accordance with the TCC. Newly issued shares however would not be sold in the stock market unless issued with regards to a public offering.
- Company may opt to go through a conditional share capital increase (şarta bağlı sermaye artırımı in Turkish) in accordance with TCC. Within the scope of a conditional share capital increase, the company will issue bonds or other debt instruments to an employee with a pre-determined price or free of charge. Employee may use conversion or purchase rights after a pre-determined vesting period. If the employee opts to use conversion rights, the employee would be a shareholder of the company. Pre-emptive rights of the existing shareholders may also be restricted. Procedure of conditional share capital increase must be stipulated in articles of association of the company.
- Company may purchase its own share in accordance with TCC. It is also possible for public companies to buy their own shares from the stock market. After such purchase, the company may transfer its shares to an employee with a stock option plan mentioned above.
- Company may enter into a phantom share agreement with the employee without the actual transfer of shares. Company may offer premiums and other incentives to the employee depending on the performance of the employee or the length of the employment.
- Company may also pay dividends to employees without a stock option plan with a general assembly resolution or in accordance with the articles of association of the company.
As previously mentioned, small technology firms are in a constant need of high skilled individuals. Such firms may attract talent with a “grow together” motto by providing employees stock options. However, as most of the firms would be a non-public company, their options are quite limited. The founders of the company may not want an employee to be a shareholder of the company as the employment may be terminated in the future; squeezing out would be challenging and a shareholder may not be forced out of the company by a share transfer. Such challenge may be avoided by the provisions of a shareholder agreement or even in an employment agreement. A well-rounded phantom share agreement may also be quite useful for a small technology firm as it is more flexible compared to a share transfer. A hybrid approach may also be used such as share transfers to the senior employees and phantom share agreements with others. The company may also distribute dividends and decide on the employee dividend distribution policy and its own discretion.
To avoid future disputes, employee stock options based on performance must be diligently planned. Performance criteria must be set objectively with a little room for subjectivity. Post-employment termination period is also crucial because the employee may claim the entitlements if the rules regarding the employee stock options are not clearly specific.
Author: Batuhan Ecin