After you set up your new company, one of the first legal documents you will be thinking about is an equity incentive plan, sometimes referred to as an “option plan” or an “ESOP”. This is key to motivating early employees, who may be taking a lower base salary for a share in the “upside” based on the company’s future success. This is the same in Singapore as anywhere else—though in Singapore there are certain market norms and legal considerations that vary from the U.S. and other jurisdictions.
The purpose of this article is to give a general overview to founders in Singapore who are thinking through the contours of their equity compensation arrangements and how to best incentivize their employees. This overview will also be useful for founders with operations in other jurisdictions in Asia or elsewhere who have chosen to set up their holding company in Singapore. It is important to note that many of the concepts below are general observations, but plans can and do vary.
Form of Award
For most Singapore-based early stage startups, the most appropriate form of incentive equity award is options. An option granted to an employee gives that employee the right (subject to certain vesting and other conditions) to acquire a number of ordinary shares of the Company for a certain exercise price. Although there are other forms of incentive equity awards, e.g. shares subject to “reverse vesting”, those sometimes come with additional challenges in the context of incentive equity granted to rank and file employees of an early stage startup. Chief among them being capital maintenance rules that make claw back of issued shares complicated.
Although startups will often informally promise their earliest employees options, it is important to formally document this as soon as possible, and certainly before the first equity funding round. The document that sets out the terms of the options and the administration of the plan is commonly referred to as an Employee Share Option Plan (or an “ESOP”), and it is accompanied by a form of offer letter (which the company uses to grant options to specific employees) and a form of exercise notice (which the option holder will deliver to the company when exercising its options). ESOPs can also be expanded to benefit consultants and advisers (i.e., not just employees) to suit the company’s needs.
Similar to the U.S., the most common vesting schedule in Singapore is a four-year vesting schedule with a one-year “cliff”. This means that 25% of the options vest after one year (typically measured from the day the employee joins the company). After the cliff, the remaining options vest in 36 equal installments each month through the end of the 4-year period. If the employee leaves prior to the end of the vesting schedule, then all unvested options are cancelled without additional payment.
Also referred to as the “strike price” or “subscription” of an option, this is the amount of money that must be paid by the employee to the company when he or she exercises the option. The value of an option at the time of exercise is the delta between the exercise price and the value of one of the company’s shares at that time. In the Singapore market, we often see the exercise price being set at either a nominal price (e.g. S$0.01 per share) or the fair market value of one of the company’s shares at the time the option is granted. There are pros and cons to both approaches which you should take into account.
When the option has a strike price equal to the fair market value at the time of grant, the employee profits only from the increase in the value of the company following the date they joined (i.e. the time period during which they were contributing to the company’s success). Conversely, if the option has a nominal strike price, then the employee benefits from the value created in the company before they joined.
Tax issues for US taxpayer employees
There can be adverse tax consequences for employees who are US taxpayers (generally US citizens or permanent residents) who receive options with an exercise price below fair market value. This is true even if those employees live and work in Singapore. Of course, a company could grant options to their US taxpayer employees with a fair market value exercise price, while granting nominal price options to their other employees. But establishing a general rule of granting at fair market value prevents inadvertent foot faults in respect of US taxpayer hires down the road. (Note: Depending on the number of US taxpayer employees a company has, it may make sense to incorporate a US “sub-plan” or other incentive equity structures in order to ensure favorable tax treatment for those US taxpayer employees.)
The lower the exercise price of an option the higher the value of that option is. Although detailed discussion of financial accounting principles is beyond the scope of this article, suffice to say that options with a nominal exercise price would result in greater non-cash equity compensation expense on the company’s financial statements.
Term, termination and buy-back
The term of the options, i.e. the period during which the options may be exercised, is typically 10 years from the grant date. However, if an employee leaves the company, there is typically a short window following their departure during which they can exercise their options. If they do exercise their options (or already hold shares due to a pre-termination exercise), then the company will typically have the right to buy back those shares, with the price paid depending on the circumstances of the employee’s departure. Note that because of capital maintenance rules, there are restrictions on a Singapore company buying back shares, including solvency requirements, shareholder approval, and limitations on number of shares of a given class that may be bought back during a given annual period. The plan documents would sometimes provide for the company to have the ability to buy back the options themselves (as opposed to the shares) prior to exercise, as there are no such restrictions on buying back options. An additional consideration is that a Singapore private company has a 50-shareholder limit (excluding present employees), which becomes complicated if there is a high turnover and departed employees exercise their options. We recommend that you consult with qualified Singapore counsel on these issues if they come up in your company.
Last reviewed: April 20, 2023