Legal Considerations When Issuing Share Options in New Zealand

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Table of Contents

• Disclosure Exemptions
• How Can I Issue Options?
• 1. Employee Share Option Plan
• 2. Call Option Deed
• Key Takeaways
• Frequently Asked Questions

As an early-stage startup, you may have considered issuing options in your company to retain staff or acquire services that will accelerate the company’s growth. There are various legal considerations before you issue share options in New Zealand. The company will need to consider how the company will issue options and which disclosure exemption can be relied on. This article will cover these key considerations.

Disclosure Exemptions

Before a company offers share options, it must ensure that either:

• a disclosure exemption applies to this offer; or 
• the offer complies with the disclosure requirements under the Financial Markets Conduct Act. 

Commonly used disclosure exemptions include the following: 

• relatives of the director of the company;
• close business associates;
• certified eligible investors;
• offers made under an employee share purchase scheme; and
• small offers.

The Financial Markets Authority can impose strict penalties for companies that mislead in the advertisement of financial services to customers and for not complying with disclosure requirements. It is important that the company carefully considers the disclosure exemptions. Likewise, the issue of options must fall in line with the parameters of the disclosure exemptions.

How Can I Issue Options?

There are two main ways to issue share options:

1. under an Employee Share Option Plan (ESOP); or
2. under a call option deed. 

We explore both ways below.

1. Employee Share Option Plan

Under an Employee Share Option Plan (ESOP), an employee of the company is offered options to purchase shares in the company, which are earned over a period of time (typically over three years). The idea behind the ESOP is that the employee is incentivised to participate in the company’s growth as their hard work will boost the value of their options in the future.

When issuing options, you should consider the following: 

• the number of options to offer and what vesting conditions will apply;
• the fair market value of the options at the time they are offered; and 
• whether the options can be exercised once they have vested or upon an exit event (where the company is sold to a third party).

Often, a company only allows employees to exercise their options on an exit event. If employees exercise their options before an exit event, they become minority shareholders in the company with voting rights. Having several minority shareholders who can vote at shareholder meetings may become difficult for the company to administer decisions. It may delay decision-making for key company decisions which require shareholder approval.   

Additionally, allowing employees to exercise their options before an exit event can raise many tax and accounting implications. Your company should offer options for their fair market value. Otherwise, the exercise of options will be responsible for paying taxes. The employee must pay this fair market value to exercise their options into shares. Paying to exercise shares is generally not common practice as the employee may not have the money available to purchase their shares.

If option holders can only exercise on an exit event, this is generally cleaner from a taxation perspective. In this case, option holders will receive the increased value of their options minus the exercise price and tax. 

Key Considerations

The implementation of the ESOP needs approval in line with the processes within the company’s shareholders agreement and company constitution. Typically, companies will set aside a certain percentage of equity (usually 10 – 20% of the company) in an ESOP pool which will be made available to employees once they have met their vesting requirements. As an ESOP is a form of employee share purchase scheme, they are exempt from the disclosure requirements of the Financial Markets Conduct Act provided certain conditions are met.   

2. Call Option Deed

A call option is where the company issues options for a person (the option holder) to purchase equity in the company. Similarly to ESOPs, these options can vest over a period of time. For example, the company can offer options for 15% of the company, which vest over 3 years. The option holder can exercise 5% of their options each year they vest.

Additionally, options can be subject to certain conditions depending on the nature of the relationship. For example, if someone provides services in exchange for their options (a form of ‘sweat equity’), you can insert a condition that the options only vest on completing the services.

As mentioned above, the call option deed requires approval in line with the processes within the company’s shareholders agreement and company constitution. Additionally, the call option deed should specify that once an option holder exercises their vested options, they must sign a deed of accession to be bound to the existing shareholders’ agreement. 

The requirement to sign a deed of accession is also necessary for an ESOP. Usually, the ESOP offer letter and plan rules will stipulate that the option holder agrees to be bound to the company’s shareholders agreement. Before offering the options, the company must ensure that a disclosure exemption under the Financial Markets Conduct Act applies.

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Key Takeaways

Before your company issues options, ensure this complies with one of the disclosure exemptions outlined in the Financial Markets Conduct Act. Once you are satisfied a disclosure exemption applies, your company can issue share options through an employee share option plan (ESOP) or issue options with a call option deed. The company will also need to ensure that the issue of options follows the process outlined within their shareholders’ agreement and company constitution.      

For more information or assistance issuing options, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.

Frequently Asked Questions