Employee stock ownership plan – ready for wider adoption?

Romualdo V. Murcia IIIRomualdo V. Murcia III

Imagine if majority of the working population are part owners of the company where they work. Imagine
the enthusiasm and excitement this possibility can infuse into the workplace! Aside from an increase in
productivity as a result of employees’ awareness of their share in the company’s profit, employee
retention may also remain high and result in a stable succession.

Employee ownership can be accomplished in a variety of ways: employees can buy shares of stock
directly from the company, receive stock options at a specified exercise price, obtain shares through a
profit-sharing plan, or this could be awarded as a bonus. Of these avenues, the employee stock option
plan (ESOP) is, perhaps, the least popular route to increasing employee ownership. ESOP is a kind of
employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a
trust fund, into which it contributes new shares of its own stock or cash to buy existing shares.

Given the possible benefits to the company and its employees, why is issuing ESOP not common in the
Philippines? As an auditor for almost 20 years, I only came across very few clients that offer ESOP or
similar plans to their employees. In contrast, there were about 7,000 companies in the United States
with ESOPs covering 13.5 million employees in 2014, according to the National Center for Employee
Ownership website (www.nceo.org).

Are there regulations concerning ESOP? There are regulatory, taxation and accounting policies for ESOP
already in place; the Bureau of Internal Revenue has issued Revenue Memorandum Circular (RMC) 79-
2014, while the Philippine Financial Reporting Standards has issued PFRS 2, Share-based Payment. The
Securities and Exchange Commission (SEC) has issued the implementing rules of the Securities
Regulation Code, with some provisions covering ESOP.

How about the valuation of the subject shares? Unlike the shares of publicly traded corporations whose
valuation are publicly known, there is a probable difficulty valuing the shares of privately held
corporations. However, with a lot of valuation models and techniques and a number of entities doing
valuation, there is a way to determine the value of the shares even for privately held corporations.

So, if regulation and valuation are not the issue, what then? In my opinion, the possible reason why
ESOP and similar plans do not gain traction is its unattractiveness both from the business owners’ and
the employees’ points of view.

For business owners, having employees as stockholders would mean a lot more individuals will look into
the business affairs of the corporation (e.g. demand to examine the company’s financial statements,
criticize the entity’s business strategy, etc.). Also, with numerous stockholders to consult with and get
approval from, the execution of the entity’s business plan could be delayed. Moreover, if the business
owners want to dispose of the business, possible buyers may back out due to numerous minority
owners.

On the part of the employees, some may find stock option plans unfavorable because many of them
prefer to receive their bonuses and incentives in cash. Also, employees particularly of privately held firms
may find difficulty when they want to leave the company. In addition to exit concerns, very few
corporations in our country regularly declare dividends, which creates an issue over expected returns.
To spur growth of ESOP and similar plans in our country, some incentives are, indeed, needed. For
business owners, ESOP is a path for transparency and better corporate governance. Involved employees
will be more engaged and motivated in doing their work to help the company grow, since the value of
the shares they are due to receive depends on the value of the company. The company will also be able
to free up funds for investment purposes, which could spur growth for the company. Also, employees
may ask the company to go public, which could drive up the number of publicly listed entities and could
eventually stimulate further development of the capital market in the country. The SEC may also
consider granting full exemption for shares of privately held corporations from registration with ESOP or
similar plans, regardless of the number of employees involved.

One other possible incentive is to grant tax exemption for the benefits received by employees. ESOP can
be likened to a retirement benefit plan if it is granted or converted upon retirement of the employee.
The value of the shares given can be more equitable than the traditional retirement benefit plan (which
is usually based on one-month salary for every year of service) as the converted value of the shares
received will be based on the value of the entity in which the employee has direct participation and to
which he or she has direct contribution. Also, to address the exit option issue, the company may be
required to put up a sinking or trust fund to guarantee the buy-back or cash conversion upon an
employee’s resignation.

ESOP can bring a lot of benefits and value to both the company and its employees. I believe it is the right
time for Philippine companies to seriously look into this important matter.

Boyet Murcia is Partner, Audit & Assurance of P&A Grant Thornton. P&A Grant Thornton is one of the
leading Audit, Tax, Advisory, and Outsourcing firm in the Philippines, with 20 Partners and over 700 staff
members.

As published in The Manila Times dated 25 May 2016

Charlie Ross
Chief Operating Officer
Cake Equity
An Employee Stock Option Plan (ESOP) is a method of granting equity in a business to an employee over
a period of time. It really is as simple as it sounds – the employee receives options (or rights) to be
granted real stocks in the business, as long as they comply with the rules of the ESOP (Plan Rules).

While there are multiple variations of employee stock plans around ESOPs are the most common form of
employee incentivisation for small and start-up businesses.

In our experience, an ESOP often represents the best way to incentivise an employee’s performance,
whilst still allowing the company to maintain the control it desires and not tying it down with admin.

So what are the benefits of an ESOP?

We have set out below the most common concerns we hear in relation to ESOPs, and in general, most
are fueled by simple misunderstandings.

“What if an employee leaves – I don’t want ex-employees leaving with equity in my Company”
Most ESOPs contain general ‘buy-back’ provisions, which allow the Company to buy options and stocks
back from employees in certain circumstances. One of those circumstances is when the employee
leaves. ESOPs will specify the price that will be paid for those stocks, often based on whether the
employee was a ‘Good Leaver’ or a ‘Bad Leaver’. As mentioned above, these terms can be completely
personalised for the Company, to cover any hypothetical scenario it may have in mind.

“How do I know the value of the options? I don’t want to give too much away?”
Cake can help you to get valuations for your company to be used in your ESOP.

It can also assist with providing a valuation to put a dollar value to each option. This will be helpful when
using options as a substitute for a salary. For example, rather than paying an employee a $100k salary,
you could offer a $75k salary, in addition to $25k worth of options, that will vest over 3 years of
employment at the Company. More cash left in your pocket, and more incentivisation for the employee.

“How could I ever keep track of when employees are meant to be granted stocks? And how would I find
time to do it?”
Cake can solve this issue for you. Once you’ve created your ESOP on Cake, it will automatically track time
based vesting rules.

This way, once an employee’s options have vested (and can therefore be exercised to be issued stocks in
the Company), both the employee and the Company will get a notification. From here, they simply click a
few buttons and the stock issue is complete.

We have created the platform on a ‘set and forget’ basis, allowing you to focus on the growth of your
Company, while the options incentivise in the background.

As part of your ESOP package, you will also get access to a simple dashboard for the Company to keep
track of how many options have been issued, how many have vested, and how many are left to grant to
future employees. Each employee will be provided an account where they can keep track of their
options, without seeing any other confidential information of the Company.

ESOPs seem like a no brainer – Why doesn’t every start-up have one?

Start-ups will often talk about offering stocks to early stage employees, and they will maybe even
promise it, but often, they don’t make it happen. Why not? They think it is too complicated, too
expensive and too time consuming.

Well, that was true. But now, Cake can help.

Cake offers template designed ESOPs, which can be individually altered to suit your specific needs – in
minutes. Cake can assist in getting basic valuations, the sending of offers, electronic executions, and
setting up automatic vesting rules in the platform. It’s all about setting and forgetting, and watching the
benefits roll in. Sign up today for free!

Cake makes equity easy.

This blog is designed and intended to provide general information in summary form on general topics.
The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax
advice. The contents is not intended to be a substitute for such advice and should not be relied upon as
such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our
very friendly legal partners.

Links

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