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Offering high salaries and performance bonuses can be challenging as an early-stage startup. To attract and retain startup employees, you can issue company shares or options instead. When you issue shares, the individual immediately becomes a shareholder. However, if you issue options, the individual can buy shares in the future. This article will explain how you can issue shares and options to employees.

Considerations Before Issuing Shares or Options

Before you start issuing company shares or options, you should consider the following:

  • whether to issue shares upfront or offer options;
  • the number of shares or options to offer;
  • what price to offer shares or options at; and
  • time constraints – how long an employee should work for you before they are entitled to the full value of their shares or options.

How to Issue Shares

When issuing shares, you need to comply with the Companies Act and Financial Markets Conduct Act. In addition, if your company has a company constitution and a shareholders agreement, you also need to ensure compliance with those documents.

Depending on the requirements under your governing documentation and the relevant law, you may need a board resolution and directors certificate to approve the issue of shares. Furthermore, you may also need approval from existing shareholders to ensure they approve the issue of shares to employees.

For example, pre-emptive rights may exist for your shareholders where they have the right to buy shares (proportionate to their current holding) before you can offer them to third parties such as employees. These rights will need to be waived by those shareholders before issuing the shares to your employees.

Once shares have been issued, you will need to notify the Companies Office within 10 working days. You need to tell them the following:

  • number of shares issued;
  • class of shares issued; and
  • shareholder(s) details.

Some startups will adopt an employee share scheme (ESS). Consequently, they can regularly issue shares to employees up to a predetermined agreed percentage of the company’s share capital. When offering shares to employees through an ESS using the relevant disclosure exemption under the Financial Markets Conduct Act, you need to provide employees with the following:

  • a warning statement. This is a prescribed statement that explains what the offer is and the risk of investment to employees;
  • basic information regarding the ESS; and
  • the company’s most recent annual report and financial statements.

The number of shares issued in reliance on this exemption in any 12 month period must not exceed 10% of the shares on issue as at the start of those 12 months.

Once the employee has signed all relevant documents, they will pay the company and be issued the relevant shares.

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Legal Documents for Share Issue

When issuing shares, there are some legal documents you may want to consider having. These documents can outline the terms of the share issue and regulate shareholder behaviour.

Share Subscription Agreement

When issuing shares to an employee outside of an ESS, you should ensure the company and employee enter into a share subscription agreement. This agreement will include the following key details:

  • number of shares being issued;
  • share price;
  • class of shares being issued;
  • mechanics for the investment – issue and payment; and
  • warranties given by the employee and the company.

ESS Offer Letter

If you have an ESS for your employees, you need to give them an offer letter that sets out their specific terms. The offer letter should also include the underlying rules that explain how the plan operates. 

Shareholders Agreement

If you invite employees to become shareholders in your startup, you should require that they sign your shareholders agreement. If you do not have a shareholders agreement, it is essential to put this in place before offering your employees shares. The shareholders’ agreement will set out key matters such as:

  • shareholder obligations;
  • restrictions around transferring and issuing shares;
  • exit strategies;
  • good and bad leaver provisions specific to employees;
  • dispute resolution processes; and
  • voting rights.

How to Issue Options

Like the approvals required before you issue new shares, you need to consider what approvals you need before issuing your employees options. Both the Companies Act and Financial Markets Conduct Act apply equally to options and shares. Additionally, your constitution and shareholders agreement will also be relevant. 

Like an ESS, you may decide to adopt an employee share option scheme (ESOP). Startups commonly use these to incentivise employees as they offer more flexibility than an ESS. You will need to adopt some ESOP rules which set out how the plan will operate.

You can then issue each employee an individual offer letter which sets out the main parameters of their offer, including:

  • number of options being offered;
  • vesting provisions;
  • when they can exercise the options;
  • exercise (or “strike” price); and
  • any conditions the exercise of options is subject to.

The benefit of an ESOP is that typically the rules will provide that the options vest over time as long as the employee remains employed by your business. If they leave before the expiry of the vesting period, they will forfeit some options (which will be cancelled rather than requiring the company to buy back or sell shares). Once the options have vested in full, the employee will receive value for them. However, your employee will not become a shareholder in the company until they exercise those options into shares per the rules and their offer letter. They only need to sign the shareholders agreement (or enter into a deed of accession) when they exercise their options, not when they are offered the options initially.

The Financial Markets Conduct Act governs ESOPs in the same way as ESSs. Therefore, the information disclosure obligations and other parameters discussed above apply here.

Key Takeaways

You can issue shares and options by following the rules outlined in your company constitution or shareholders agreement (if you have one), as well as in compliance with the Companies Act and Financial Markets Conduct Act. It is essential to seek legal help to comply with your obligations, as these can be complex. When issuing shares or options, you will require several legal documents, including various company approvals.

If you need help with issuing shares or options, contact our experienced startup lawyers, who can help you as part of our LegalVision membership. You will have unlimited access to lawyers who can answer your questions and draft and review your documents for a low monthly fee. Call us today on 0800 005 570 or visit our membership page.

Frequently Asked Questions

How can I issue shares to employees?

You can issue shares to employees by establishing an ESS. The Financial Markets Conduct Act regulates the ESS process, and creates some obligations to meet.

What are options?

Options mean that the employee or investor has the right to buy shares in your company in the future for a predetermined price.

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