Tips to Consider When Setting Up an Employee Share Ownership Plan

A substantial number of companies have recently installed employee share ownership plans (ESOP). Little is known, however, about how such arrangements work.

An ESOP is a share
incentive program offered by companies to their employees allowing them
to acquire shares in the company. Having an ESOP is an added incentive
to productivity and commitment of employees. This is because they play a
part in the ownership and the decision making of the company. Further,
dividends from an ESOP by a listed company, when registered with the
Kenya Revenue Authority, qualify for tax benefits.

1. Types of ESOPs.

The Kenyan
legislation governing ESOPs includes the Companies Act 2015, Trustees
Act, common law and the Capital Markets Authority Collective Investment
Schemes Regulations, 2001 which govern ESOPs in listed companies. Given
the undeveloped nature of the ESOP regulations in Kenya, it is submitted
that the United Kingdom's statutory schemes regulations provide
necessary guidance as to the structure of the main schemes used today.

There are 3 types of schemes in use:

1.1. Profit sharing scheme – this is based upon a trust, which must be established for the purpose. The trustees receive payments from the company and apply these
payments in acquiring the ESOP shares. These shares are then
'appropriated' by the trustees to eligible employees in accordance with
the trust deed and rules of the scheme.

1.2. Savings-related share option schemes –
this is linked to a savings contract. The eligible employees are
offered options to subscribe for the ESOP shares with the price payable
on exercise being fixed at the date on which the option is granted.

1.3. Share option scheme –
participants are granted options to acquire the ESOPs shares. The
subscription price is fixed at the date of grant of the option. There
may be provisions requiring exercise of the option within strict time
limits.

2. Questions to ask before adopting an ESOP.

2.1. Will the succession plan in place get the most out of your company? Having
an ESOP will ensure a seamless succession plan since it is attributed
to improved productivity, profits and share value. The participating
employees in ESOPs give their best to the company since their interests
are in line with those of the management and shareholders.

2.2. Is your company big enough?
To establish an ESOP, a company is going to need an advocate, a
valuation expert and a trustee for the ESOP program. Then, there are
continuing compliance and costs for tax returns and annual valuations.

2.3. Are you ready to share your financials? At the very least, you will have to allow the participating employees access to the audited accounts of the company.

3. What are the legal issues arising when dealing with ESOPs

3.1. Capacity of the company to establish the ESOP

A company
may only establish an ESOP if it has the corporate power to do so under
its memorandum and articles of association. Some provide for a specific
power to establish an ESOP, but a more general power to remunerate
employees should otherwise suffice. If the objects clause of the
memorandum of association needs to be extended to enable the setting up
of an ESOP, then the alteration needs to be made by a special resolution
in line with the Companies Act 2015.

3.2 Availability of authorized share capital

It is
necessary for a company, which adopts an ESOP to have sufficient
authorized but unissued share capital for the allotment of shares under
the scheme. If the authorized share capital is insufficient, it can be
increased by an ordinary resolution of shareholders in accordance with
Section 405 of the Companies Act 2015.

3.3. Financial assistance

The
Companies Act 2015 permits a company to provide financial assistance for
the purchase or subscription of its shares with respect to setting up
an ESOP. This financial assistance is available to employees or former
employees, spouses, widows, widowers or surviving, or minor children or
step-children of any such employees or former employees .

3.4. Trust Deed and Rules of the ESOP

The
eligibility of employees, procedure of participating in the scheme,
rules of exit, allotment, meetings and other rights and obligations of
the parties are usually prescribed by the trust deed and the rules. A
clause on the conditions of the vesting of the benefits must be provided
for in the trust deed and the rules. It must be clear and notified to
the participating employees. This will ensure fairness to employees and
not result in instances where an employee feels short changed when they
leave.

3.5. Corporate and Tax due diligence.

It is
necessary to conduct a corporate and tax due diligence to determine any
regulatory issues surrounding the company setting up an ESOP. This will
involve the study of the various applicable laws, review of relevant
documents and structuring. Only then can the transaction advisors
propose an appropriate structure and framework for setting up the ESOP.

3.6. Consequences of termination of employment

For an ESOP
by a listed company, the exit procedure is prescribed under the Capital
Markets (Collective Investment Schemes) Regulations. With respect to
companies that are not listed, the trust deed and the rules prescribe
the procedure of the exit of employees from an ESOP upon termination of
their employment. The trust deed should expressly provide for leaving of
service before and after the vesting of their benefits. Where the
employee leaves the company before the vesting period is over, they lose
the right to cash in on the shares.

4. What should be in the trust deed and rules of an ESOP?

4.1. Who can participate in the ESOP.

An ESOP
will need to make provision in its rules for participation in the
scheme. These will include rules on eligibility and participation
limits.

4.2. Shares and Share Price

A company
may choose to offer its employees the opportunity to acquire shares out
of their own resources and it may, for this purpose, create a special
class of shares. Such shares are sometimes referred to as employees'
shares. Employees' shares may be given any rights which the company
chooses.

An ESOP
will need to make provision in its rules for the market value and price
of its shares, including rules as to the price at which the ESOP shall
allot the shares to the employees and the price at which the trustees
shall re-purchase units.

4.3 Transfer of Rights

A
n ESOP
will need to make a provision in its rules for the transfer of rights
arising from the ownership of shares. These rules will differ depending
on the type of scheme in use. The company should therefore set up
conditions that must be met before the shares vest in the participating
employee.

5. Requirements for an ESOP established by a listed company

The Capital
Markets (Collective Investment Schemes) Regulations prescribe some
reporting requirements for an ESOP established by a listed company. The
listed company is required to disclose any options granted to its
employees under the ESOP. Listed companies must seek approval from the
Capital Markets Authority before establishing ESOPs and they must upon
formation, be registered with the Capital Markets Authority.

Conclusion

Research shows that
the presence of an ESOP at a workplace is significantly associated with
employee commitment, higher-performing workplaces, better compensation
for employees and increase in profits.

Given the potential
economic and social benefits of ESOPs, public policy should seek to
ensure the improvement of the existing laws governing ESOPs in Kenya to
address the various governance matters while considering best practice.

1Section 446 (b) of the Companies Act 2015

2Section 446 (c) of the Companies Act 2015<

Article written by Carole Ayugi, Managing Partner and Elvis Wanjau, Junior Associate, MMAN Advocates.

Disclaimer: This
article has been prepared for informational purposes only and is not
legal advice. This information is not intended to create, and receipt of
it does not constitute, a lawyer-client relationship. Nothing on this
article is intended to guaranty, warranty, or predict the outcome of a
particular case and should not be construed as such a guaranty,
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information contained in this article and in no event shall be liable
for any damages resulting from reliance on or use of this information.
Readers should take specific advice from a qualified professional when
dealing with specific situations.

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