Employee Share Option Plans (ESOPs) are increasingly popular in New Zealand as a means to incentivise and reward employees. A key consideration when structuring your ESOP is the inclusion of a vesting regime. Vesting can be time-based, performance-based, or a combination of both. This article discusses time-based vesting only. Time-based vesting refers to the timeframe that employees must remain with the company to realise the benefits of their allocated options fully. This article will take you through seven key points to understand about time-based vesting.
1. Understanding Time-Based Vesting in ESOPs
In the context of ESOPs, vesting is the process by which employees earn the full rights to their allocated options. Often, it enables them to exercise those options into shares. Vesting is designed to promote loyalty and long-term commitment by ensuring that employees are rewarded for their continued service and contribution to the company’s success. Vesting periods vary depending on the specific ESOP and the company’s requirements.
2. Compliance
Both the Financial Markets Conduct Act and the Companies Act are relevant when implementing an ESOP in New Zealand. This is because issuing options constitutes the issuing of a security. Given securities law is highly regulated in New Zealand (and elsewhere), it is recommended that you seek legal advice to understand these requirements and ensure compliance.
Continue reading this article below the form3. Customising Time-Based Vesting Schedules
One of the critical decisions you will make when designing an ESOP is determining what time-based vesting applies. This refers to:
- the period during which an employee must stay with the company; and
- any other conditions that must be met before the relevant employee is entitled to the full benefits of their allocated options.
Importantly, companies can customise the vesting schedule to suit their specific needs and objectives. In regards to time-based vesting specifically, common vesting structures include the following:
| Vesting Feature | Explanation |
| Cliff | The “cliff” is an initial period during which, if the employee leaves, they will not be entitled to any benefit under the ESOP. At the end of that period, a portion of the options vest at once (being the amount that would have vested if they had gradually vested during that period). The cliff ensures that employees who are still new to the company do not benefit from the ESOP if they leave within a short period. The market standard cliff period is 12 months. |
| General Vesting | General vesting allows for the gradual vesting of options over time. It typically involves vesting in: + equal portions; or + percentages at regular intervals, such as monthly or quarterly. The typical total vesting period is 3 to 4 years, including a 12-month cliff. |
| Immediate Vesting | Immediate vesting can be used where, for example, an employee has contributed significantly to the growth of the company prior to an ESOP being put in place. Effectively, their options immediately vest in consideration for the time given to the company to date. |
4. Employment Contracts
Employment contracts and contractor agreements play a crucial role in connecting the participant’s service to the company with the ESOP. Typically, the ESOP will cross-refer to the contractor or employment relationship in place, ensuring that when that terminates, vesting automatically ceases, and a process is followed in regard to any vested options.
5. Forfeiture and Acceleration
ESOPs may include forfeiture provisions (in respect of both vested and unvested options) that allow companies to reclaim allocated options in certain circumstances, such as:
- termination for cause; or
- voluntary resignation before the vesting period is completed.
Further, some ESOPs may include acceleration provisions that allow for immediate vesting in the event of specific triggering events, such as:
- a change of control; or
- acquisition of the company.
6. Communication and Transparency
Clear communication and transparency are essential when it comes to the vesting regime for ESOPs. Typically, this should be clearly set out in the relevant employee’s offer letter, which your legal advisor can assist with.
Further, regularly updating employees on the status of the vesting of options or providing them with direct access to that information helps ensure “buy-in” and continued engagement and strong performance from such employees. This facilitates the continued growth of the company.
7. Tax Implications
It is essential to consider the tax implications associated with ESOPs. In New Zealand, employees typically incur income tax obligations on the exercising of vested options (or on completion of the vesting of shares, if issued subject to vesting). You should seek guidance from tax professionals to understand the tax treatment and obligations for both your company and employees.
Understand how an Employee Share Scheme will help your NZ startup attract and retain great talent.
Key Takeaways
Vesting regimes play a vital role in the design and administration of ESOPs in New Zealand. Some key points to understanding about vesting requirements include:
- what vesting is;
- ensuring compliance with the relevant law;
- customising vesting schedules to specific company and participant requirements;
- the impact of employment and contractor agreements;
- inclusion of forfeiture and acceleration provisions;
- the importance of communication and transparency; and
- the impact of taxation.
If you need assistance understanding what to include in your pitch deck, you can contact our experienced startup lawyers to assist 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 at 0800 005 570 or visit our membership page.
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