Employee incentive schemes are gaining popularity as more companies are trying to be creative in boosting employees’ compensation and benefits package. While share incentive plans such as Employee Share Option Schemes have been commonly used by start-ups and tech businesses, the more traditional brick-and-mortar businesses have also embraced the use of employee incentive schemes.
In this article, we discuss how a company in a trading business structured its incentive schemes to achieve the overarching goal of rewarding employees and aligning the interests of employees with the interests of the company, and the key considerations taken into account in structuring the schemes.
The company had 2 objectives in mind, to allow its selected long-serving top employees to be a shareholder in the company, and to allow its mid-level employees to share part of the company’s profits without being a shareholder in the company. With this in mind, the company implemented a Profit Sharing Plan and a Share Award Scheme.
Profit Sharing Plan
In a Profit Sharing Plan no actual shares or right to obtain shares are granted to the employees. Instead, a profit sharing plan allows a company to allocate a percentage of the company’s profits for distribution among the selected employees.
The key things considered include:
- What are the eligibility criteria? While the selection of participants is at the company’s discretion, having a set of clear eligibility criteria increases transparency on how the plan is administered;
- What is the amount or percentage of profits allocated for distribution each year? Is this amount fixed by the company or benchmarked against the company’s performance of the year?
- Do the participating employees have to satisfy any extra Key Performance Indicators (KPIs) to receive the distribution under the plan?
- How would the amount be distributed among the participants? Would it be distributed equally among all participants or pro-rata based on when the participant was inducted into the Plan?
- What financial data will the company be willing to share with the participants, so the participants can verify that the amount received tallies with their entitlement?
The above is a non-exhaustive list of key commercial terms in a profit-sharing plan but they demonstrate some issues that need to be considered and decided by the founders or management of a company if they implement a profit-sharing plan.
Share Award Scheme
A Share Award Scheme involves the issuance of shares at a nominal amount or for free to the employees so employees get the upside of being a shareholder in the the company and receive the company’s profits in dividends. As shareholders, they can also attend and vote in the company’s shareholders’ meetings.
Share Award Schemes are less common than Share Option Schemes, as it involves the issuance of shares outright with minimal or no payment. Companies should only award shares to employees who have “proven themselves” and have significantly contributed to the company’s growth.
While Share Award Schemes are used by companies to award their top performers, the goal of rewarding employees and allowing them to be a shareholder has to be balanced against the founders’ need to have control over composition of the company’s shareholding. There would always be a risk of an employee resigning or leaving the company, and so mechanisms on how to deal with such exiting employees’ shares should be carefully crafted. For instance, will the employees be able to stay on as a shareholder despite their exit or will this trigger a call option for the founders to buy the shares?
A share award scheme can be structured such that the shares granted are still subject to a vesting period before the shares are issued. This means that only upon the shares being fully vested, would the employee then be able to sell his or her shares. Such restrictions on the employee’s right to sell their shares and also a call option for the founder to buy the shares upon an employee’s exit are crucial considerations towards ensuring that the founders still have control over the composition of the company’s shareholding.
The above highlights some of the key considerations that a company should consider in structuring its employee incentive schemes. However, there is no one-size-fits-all and each company would have their own goals and priorities for structuring their employee incentive schemes.
The bottom line is that the company needs to be clear on how implementing a scheme will affect the company, be it from shareholding composition or allocation of profits for distribution, and what the consequences are if the employee leaves the company.
This article was written by Shawn Ho and Ee Lyne Chong. Shawn leads the corporate practice group of Donovan & Ho, and has been recognised as a Notable Practitioner, whilst the firm has been recognised as a Notable Firm for Corporate and M&A by Asialaw Profiles 2020 and 2021. We are also ranked as a Recommended Firm by IFLR1000 2020 and 2021.
Our corporate practice group advises on corporate acquisitions, restructuring exercises, joint venture arrangements, shareholder agreements, employee share options and franchise businesses, Malaysia start-up founders and can assist with venture capital funds in Seed, Series A & B funding rounds. Feel free to contact us if you have any queries.