An ESOP program — depending on whether it is based on the participant’s ability to acquire “real” shares/equity, subscription warrants, or “virtual” shares/equity — carries varying levels of security.
Introducing an ESOP structure based on “virtual” shares/equity into the company — due to the fact that it does not result in actual changes to the ownership structure — appears to be the solution offering the relatively highest level of security.
Nevertheless, it is essential to ensure that the documentation governing the program includes provisions that protect the entrepreneur in several additional areas. Below are a few selected examples:
The first issue to be clarified is the obligation to maintain a high level of confidentiality — both regarding the general principles of the program and the method for determining the Exit Price (notably, this price may vary depending on who is admitted to the program). Additionally, many entrepreneurs aim to keep the existence of the program confidential within the organization, reserving it exclusively for selected individuals. Such a high level of data confidentiality must be reflected in the regulatory solutions applied.
Another important area to secure is the participant’s position in the event of issuing additional shares/equity or expanding the scope of the program — the company must not be exposed to any “anti-dilution” claims from the participant. It is also necessary to safeguard the company’s ability to modify the program at virtually any time (this is particularly important in the event of transferring the company to another jurisdiction or converting it into a different type of company/corporation). Furthermore, the program’s rules should specify the procedure in the event that a participant transitions to employment or cooperation with an affiliated company — this raises the question of what happens to their existing participation and acquired rights.
Another significant and extensive issue is the regulation of tax liability rules within the program. It must be clearly defined (to avoid future misunderstandings with participants) who pays and for what. Neither the company, nor its shareholders, nor its management may bear responsibility for any consequential damages suffered by a program participant, including lost profits. It is crucial that the ESOP implemented in the company does not result in any declarations — either regarding the company’s potential profits or, more importantly, the participant’s estimated gains. This will help avoid potential claims from the participant.
