Most startups in NZ put an employee share option plan (ESOP) in place. ESOPs are a critical building block for high growth companies to incentivise key people to stick around, and to hire talent.
First off the block is this guide on company administration. We’ll then follow up with a summary of the compliance and governance matters to consider. Finally, we’ll give some thought to key terms of ESOPs, using our experience of having advised many startups over the years in NZ and overseas.
Whilst we provide free templates, we always recommend startups work with an experienced law firm when it comes to ESOPs. ESOPs are often put in place early on, but they do need to be fit for purpose for the whole life cycle of the company, and are a key document which can cause issues on exit if not well drafted.
We’ve fielded some interesting questions recently from companies who have created employee share option plans (ESOPs) but who haven’t yet made any grants to team members. The questions included whether they had to issue new shares representing the new ESOP pool, and whether they needed to add the ESOP to their shareholding information on the NZ Companies Office website.
The short answer to both questions was no. We thought it might be helpful to explain why.
relationship between your ESOP and your cap table, share register, and Companies Office website records
ESOPs involve granting options to team members. Options aren’t shares – they’re contractual rights to buy shares in the future at a fixed price and on pre-agreed terms. No shares are issued under an ESOP until a team member who has been granted options exercises some/all of those options to buy new shares.
what to put on the NZ Companies office website and share register
Your NZ Companies Office website shareholding records, and your share register, are a record of shares actually issued by the company. Because options aren’t shares, the ESOP doesn’t affect those records until options are exercised, and new shares are issued.
What does the ESOP affect from day one? Your cap table.
what to put in your cap table
Your cap table should clearly show how many shares your company has issued, and who holds those shares. In that respect, the cap table mirrors your share register and your NZ Companies Office website records.
However, your cap table should go further than that, to show the fully diluted capitalisation of the company at any given time. Your fully diluted capitalisation is all of the issued shares and all of the shares you have plans, or are obliged, to issue under the ESOP, and in connection with convertible notes (if you’ve entered into any), etc.
Once you’ve set up an ESOP, your cap table should be updated to add columns showing everyone’s shareholdings on a fully diluted basis., i.e. showing what the shareholdings in the company will look like if all of the options available in the ESOP are granted and exercised. Someone who owns 25% of the company calculated solely by reference to shares actually issued will hold less than 25% on a fully diluted basis, when calculated by reference to shares actually issued plus the ESOP pool.
what to put in your options register
Separately, you should also be keeping an options register that records all of the options you have granted, and the vesting schedules, expiry dates, exercise prices and exercise dates of those options. You don’t need to include all of that information in your cap table, but it should be consistently and accurately updated, and readily retrievable, to ensure you have a handle on your ESOP grants.