Employee stock options vs Employee stock ownership plan

In addition to funding issues, talent retention is also a significant concern for startups. While external fundraising can solve the funding problem, it does not address the issue of talent attrition. This article introduces “Employee Stock Options” and “Employee Stock Ownership Plan (ESOP).” These approaches not only enable startups to obtain partial funding but also help retain valuable talent, thereby avoiding talent loss.

I. Employee Stock Options

1. Employee stock options refer to agreements signed between startups and employees based on relevant company laws and approved by the board of directors. Under these agreements, employees have the right to purchase a specific number of company shares at a predetermined price and under specified conditions within a certain period. After the agreement is made, the company issues stock option certificates to employees. Once employees acquire these certificates, they cannot transfer them to third parties, except through inheritance.

1. For companies with a par value for their shares, the exercise price of stock options cannot be lower than the par value. However, there are no limitations on the employee’s exercise period, price, and quantity, and the company is not required to make any declarations to regulatory authorities for issuing stock option certificates. In the case of startups without a par value for their shares, there are no restrictions on the exercise price of stock option agreements.
2. Employee stock options can be structured with a phased approach. For example, after one year of the stock option agreement, an employee can purchase 1,000 company shares at $10 per share. After two years, they can purchase an additional 1,000 shares at the same price, and so on. This approach enhances the effectiveness of retaining employees.
3. Taxation on employee stock options: When employees exercise their stock options, the price at which they purchase company stock is often lower than the market price. The price difference is considered as additional income for employees and is subject to income tax.
4. The cost of issuing employee stock option certificates is recognized as the company’s annual salary expense when reporting corporate income taxes. The company does not need to withhold taxes when employees exercise their stock options. However, according to Article 89, Paragraph 3 of the Income Tax Act, the company needs to report to the tax authorities and provide employees with withholding exemption certificates.

II. Employee Stock Ownership Plan (ESOP)

ESOP is a plan where a company reserves a portion of its issued shares or specifies a certain number of shares within its articles of incorporation for the purpose of an employee stock option plan. When employees meet specific conditions (usually based on length of service or performance indicators), the company transfers a predetermined quantity of shares to the employee free of charge, according to the contractual agreement between the company and the employee.

1. ESOP does not have any legal procedural restrictions and offers more flexibility. It is usually created by allocating shares from the original investors or founders’ holdings, which are held by a founder on behalf of the employees before distribution. To ensure compliance with agreements between the company and the holding founder, a stockholding agreement is signed. This agreement defines the number of shares and the corresponding rights and obligations to safeguard the interests of both parties.
2. From a tax perspective, since ESOP often involves founders transferring their held shares to employees without charge or at a low price, it falls under the purview of inheritance and gift taxes as defined by Taiwan’s tax laws. Therefore, appropriate transaction or gift taxes should be levied.

Based on the above, both employee stock options and ESOP serve as alternatives to cash compensation to incentivize employees. On one hand, they save the company’s cash outflow, and on the other hand, they establish contractual requirements for employees while aiming to encourage their long-term commitment to the company.