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How Can My NZ Startup Offer ESOPs to Contractors and Advisors?

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Given the competitive nature of the startup landscape, it is crucial your startup attracts and retains talented individuals. You need these talented individuals in order for your startup to be successful. Employee Share Option Plans (ESOPs) have become a popular tool for incentivising employees and aligning their interests with the company’s long-term goals. Traditionally, ESOPs have been thought to apply to employees and permanent employees only. However, your startup can offer the benefits of an ESOP to your contractors and advisors. This article will explore how your startup can offer ESOPs to your contractors and advisors.

Understanding ESOPs

It is first crucial you understand the fundamentals of ESOPs. ESOPs are programs that allow participants, whether they are key employees, independent contractors or advisors to own a stake in your company. This usually occurs by allocating share options to the participant you had in mind. ESOPs serve as a useful tool for incentivising your independent contractors and advisors and fostering loyalty.

It is vital that you effectively navigate the NZ legal requirements and regulations when you are considering offering ESOPs to your contractors and advisors. As such, you should first consult with a legal professional to ensure your employee share scheme is in compliance with the relevant legislation. 

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Defining Eligibility Criteria

Under the relevant legislation, ESOP benefits are able to be extended to contractors and advisors. However, you may want to ensure your ESOP clearly defines the eligibility criteria for participants. These criteria may differ from an ESOP you already have in place for your employees. 

When defining eligibility in your ESOP plan, you may want to consider factors such as:

  • the duration of their engagement with the company;
  • their contribution to the company’s growth; and 
  • the potential impact of their work. 

Carefully defining these criteria in your ESOP plan ensures that you offer ESOPs only to those individuals who contribute significantly to your startup’s success. Further, only individuals who are truly aligned with the long-term success of your startup will be rewarded. 

Valuation and Allocation

Determining the value of the company and allocating share options to participants requires careful and extensive work on your part. You may find it beneficial to engage with professionals who are experienced in startup valuations and equity compensations. These professionals can help ensure that the process of allocating share options to your participants is fair and transparent. 

Further, you must develop a clear methodology for valuing and allocating share options to your participants. A clear methodology is needed so you can avoid potential disputes and maintain a positive working relationship with your participants. These may include your key employees, independent contractors or advisors.

Communication and Transparency

Transparency is essential when implementing ESOPs for your contractors and advisors. You should always clearly communicate the ESOP rules and potential benefits (or otherwise) to all participants. 

You should regularly update participants on the company’s progress and give them the tools to understand the value of their equity holdings and company shares. Overall, creating and maintaining open lines of communication with your contractors and advisors fosters trust. Also, clear and transparent communication facilitates greater motivation and a stronger commitment amongst your contractors and advisors to grow your company.

Tax Implications

It is imperative that you consider the tax implications associated with ESOPs for your participants. You should seek guidance from tax professionals to ensure your ESOP is in compliance with New Zealand’s tax laws. Additionally, you should also make your contractors and advisors aware of any tax obligations that may relate to their equity holdings. For example, your contractors and advisors may have to pay income tax or capital gains tax on their equity holdings. 

Assess Contractor Classification and Alternatives 

It is also critical to explore New Zealand’s Financial Markets Conduct Act and understand how this impacts your contractors’ ability to participate in ESOPs. This Act outlines certain disclosure exemptions for ESOPs. This allows eligible persons to participate in ESOPs without requiring full disclosure.

Under this Act, ‘eligible persons’ include:

  • employees; 
  • directors; and
  • service providers (which relevantly includes contractors).

The benefit of the ‘no full disclosure’ requirement is that it provides your startup with flexibility. Your startup faces a reduced administrative and regulatory burden regarding offering financial products to your staff. 

However, there are strict requirements that must be met for your startup to be exempt from this disclosure requirement. For example, full disclosure is not required if:

  • the offer is made as part of the remuneration arrangements for the eligible person;
  • raising funds for the issuer is not the primary purpose of the offer to the eligible person; and
  • the total number of specified financial products issued or transferred under all of the issuer’s employee share purchase schemes must not exceed a certain amount within a 12-month period.

Your startup should adhere to these specific conditions to be exempt from the disclosure requirements. Further, your startup should adhere to these disclosure requirements to ensure compliance with the relevant regulations. As such, it is highly recommended that you seek legal advice to stay informed about changes to legislation impacting ESOPs. 

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Key Takeaways 

You may offer ESOPs to your contractors and advisors as well as your employees. As such, ESOPs are a useful mechanism to attract and retain top talent for your startup. In general, ESOPs operate the same way in respect of contractors and advisors as they do for employees. Before implementing an ESOP in your startup, you must: 

  • understand ESOPs;
  • consider New Zealand’s legal landscape;
  • define eligibility criteria;
  • create the structure;
  • consider valuation and allocation;
  • know the importance of communication and transparency;
  • consider the tax implications; and
  • assess contractor classification and alternatives.

If you need assistance understanding how you can offer ESOPs to your contractors and advisors, contact our experienced employment lawyers 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

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Emily Young

Emily Young

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