Employee Stock Option (ESO) -- a beneficial plan for both the company and the employees

Anita Ghazi Rahman | Wednesday, 22 December 2021

The Government's latest 8th five-year plan (FYP) has set a job-creation target of 11.33 million between FY 2021-2022 and 2024-2025. This plan is a more ambitious target for job-creation than the 7th FYP, of which 73.6 per cent was met. Bangladesh adds 2 million new entrants to the job market year-on-year.
For the new entrants seeking employment in corporates, the consideration nowadays is more and more between MNCs offering good/comfortable pay packages or fast-growing disruptive startups. The startup ecosystem has already created 1.5+ million jobs in Bangladesh. However, when it comes down to it, a person having job offers from both types of companies would often choose an MNC even when a highly promising and disruptive but lean home-grown company's vision and mission might resonate with her. This scenario can change and more talent can be retained by home grown companies if one small change can be made - allowing the introduction of employee stock options (ESOs) or ESO plans (ESOPs) in Bangladesh. Bangladesh has already seen stock being given to employees with lucrative returns when companies have listed in the stock market [recent examples being Robi Axiata, Midland Bank], but although the will is there, Bangladesh is yet to build an ESOP-culture due to the absence of a clear and workable structure to implement ESOs directly. A legal framework recognising employee stock in unlisted companies in Bangladesh is missing, although ESOPs have become a textbook approach to compensation for tech companies in the US, Singapore and China, and taken off in India as well, to name just a few jurisdictions.
To start with, employee stock options (ESOs) are basically a stock-based form of compensation offered by private companies to its employees. The mechanism of granting of ESOs may differ depending on jurisdiction. However, generally ESOs are governed by an agreement that gives eligible employees the right to purchase shares in the employer-company in the future at a pre-determined price (called the "exercise price") or shares are issued to employees directly through profit-sharing plans or bonuses, and the employer has the discretion to decide who can avail the options.
For many early-stage companies, where cash flow is limited and recruiting top talents is the key to growth, ESOPs can supplement employee remuneration packages and can be key to attracting, involving, motivating and retaining employees by giving them a stake in the ownership of the companies, while allowing the companies to reserve cash for business operations. Often a lower salary can be compensated with a larger ESOP stake.
ESOPs have been a highly debated matter across South Asia., and now more than ever, many tech talents are willing to accept ESOPs in place of a higher salary or bonus. This is because although startups take time to grow, employees often believe in the company's growth potential and are willing to take a risk on the company's future success, being directly involved in building value for the business. Employees are often willing to take a calculated risk on smaller salaries when they believe they can directly grow the company and get much larger returns later.
Organisations often use employee stock ownership plans as a tool for attracting and retaining high-quality employees usually by distributing the stocks in a phased manner. For instance, a company might grant its employees the stocks at the close of the financial year, thereby offering its employees an incentive for remaining with the organisation for receiving that grant. Companies offering ESOPs have long-term objectives. Not only do companies wish to retain employees for a long-term, but also intend to make them the stakeholders of their company. IT companies have been known to have high attrition rates - loosing employees to higher pay and benefit packages to companies at home or abroad. ESOPs could help such companies, making employee compensation packages more competitive, commensurate with the valuation of the company. The higher the company is valued, the higher the return on the stock.
What we see in Bangladesh presently are round-about systems of putting in place contracts (either through employment contracts directly, or otherwise) whereby bonus is paid or the company somehow comes to a mechanism of giving certain employees (generally key or first employees) some additional payout in order for them to utilise the same towards share purchase. This is cumbersome, involving multiple steps, consents and variables and basically complicating what should be a straight-forward process.
The process of rolling-out ESOs should be straight-forward and standard across the board and ensuring that structure and process as a recognised legal concept is the job of the legislature. There are many consideration on what ESOPs in Bangladesh should look like-- what ESOP structure should be used to attract and keep talents? How much equity are investors comfortable with issuing as ESOPs? What happens during exits? How will accelerated vesting work? What happens to vested options of ex-employees? What is the tax implication going to be?
And while we discuss whether ESOPs should be introduced in Bangladesh -- how and whether to implement them -- global trends keep evolving and morphing into even newer concepts and practices. A recent such concept is the concept of cash-settled schemes such as Share Appreciation Rights (SARs) and Phantom Stocks in countries like India, where shares can be offered not just to employees but also with consultants, advisors, founders/promoters and non-employees. But that is another conversation much down the road - the first step for us in Bangladesh is to recognise ESOs / ESOPs.
Our company law, as it presently stands, prohibits rendering 'financial assistance' by a public company to a person for the purchase of its own shares. Such prohibition was formulated since it resembled the purchase by a company of its own shares and was objectionable for violating the capital maintenance doctrine. Thus, the capital represented by issued share capital (plus share premium account) of the company cannot be reduced except through an order of the High Court. Interestingly, this provision of the law appears to deal with a company giving financial assistance for 'purchase' of shares, and not 'subscription' of its shares. Furthermore, even if the 'purchase' versus 'issue' problem in the Companies Act is resolved, there are still problems in the practical implementation of issuance of shares at the registrar of joint stock (RJSC) at 'zero value' or for 'in-kind' services rendered by employees although there is provision in the Companies Act to address this.
In practice, even where the law allows it, the relevant office of the RJSC is reluctant to implement the process. This may well be because of lack of training or experience of the officers on the ground, but the question then is-- given the government's goal to increase FDI and uptick on sophisticated investment transactions in our jurisdiction which often involves share buy-back provisions, plus the pressing need for ESOPs, should this provision of our company law not be modified or removed or at least eased [ref. s.58, Companies Act of 1994]?
The other scenario we often see in granting ESO rights to Bangladesh nationals is when a foreign parent company, which already has an ESOP scheme in its home jurisdiction tries to give the benefit of the plan to its or its subsidiaries' Bangladeshi employees. The foreign exchange laws of our country [ref. Paragraph 12, Chapter 9 of the Foreign Exchange Guidelines] requires all residents who are or become owners of security in a foreign country to submit a return to the Bangladesh Bank within one month of acquiring the security or the right to the security. More often than not, a lay person is uncomfortable or hesitant to make such a submission. This is an issue of time-cost to the employee as well as not knowing how such an application will be entertained or dealt with, and whether they will have to face a host of questions from the regulator. The flip side of the hesitation is that breach of foreign exchange laws are strictly looked into by the central bank and other regulatory authorities, which may pose a risk not just to the founders but also to the company if an investigation is initiated. Given that an exercise of an ESO right will mean more inward remittance to the employees as income and also to the country, there is need for this control mechanism to be relaxed so that foreign owned companies are incentivized to implement ESO plans for their Bangladeshi employees. This should thus be a simple and standard notification process, and nothing more.
Similarly, other considerations would include the accounting cost to the company and the accounting treatment for ESOPs.
As a final consideration, it is important to look at how ESOP law can be implemented in Bangladesh. For the sake of brevity, if we take references of just Singapore and India, ESOP is regulated by multiple statues. In Singapore, ESOPs are addressed in the Singapore Companies Act, the listing manual of Stock Exchanges of Singapore, and the taxation laws of Singapore. In India, the concept of ESOP is addressed in the Indian Companies Act 2013, the Companies (Share Capital and Debentures) Rules, 2014 and the Share Based Employee Benefits and Sweat Equity Regulations, 2021issued under the [Act]. Implementation of ESO plans in Bangladesh should also look at addressing the concept either through a separate (subordinate) legislation or through amendment of the companies, securities and taxations laws to the extent required.
Introducing ESOs means everyone potentially benefits- employees are incentivised to work harder and stay loyal to the company, while the companies end up saving cash (especially at its early stages when capital is scarce). Some of the most successful internet companies in the word, including Google, Facebook, Amazon and Alibaba as well as Flipkart have reaped the benefits of this approach. As we aim to foster the growth of more unicorns in our country, gearing towards becoming a knowledge economy, our country cannot afford to leave the matter of ESOs unaddressed. This may well be a small step also towards reducing brain-drain and even work towards brain-gain into our economy.
Anita Ghazi Rahman is an Advocate of the Supreme Court and the Managing Partner at
The Legal Circle (www.legalcirclebd.com). [email protected]