Expanding your startups into the US or UK is exhilarating yet complex, particularly when administering ESOPs across multiple jurisdictions. 

We hosted an exec forum for Airtree’s portfolio with the help of industry experts Rosanna Biggs, SVP of People & Legal at Linktree and Jason Atkins, Co-founder and President of Cake, who helped us untangle multi-jurisdictional ESOPs.

Expect a high-level overview of the components you should be familiar with and issues you may encounter. We’ll help point you in the right direction so you know the right people and the right questions to ask for your startup.

US 🇺🇸

Rosanna managed the establishment of Linktree’s ESOP in the US and now, with hindsight, has some great advice for anyone looking to do the same. 

“It was a steep learning curve,” says Rosanna. “The best advice I can give you is to find excellent legal counsel in the US who not only understands the technicalities and different laws that come into this but can also help you project-manage the setup process.”

It’s also worth having a long-term plan around your initial grant and top-up strategies. This will help you effectively manage and conserve your existing ESOP pool and pre-empt conversations about increasing it over time.

Types of ESOP interests in the US

There are 3 commonly used equity constructs that companies in the US offer: restricted stock units (RSUs), non-qualified stock options (NSOs), and incentive stock options (ISOs). 

“I recommend understanding the different types of options and their impact before designing your ESOP strategy and plan,” says Rosanna. 

Let’s start with RSUs, the most common type of equity compensation. They’re simple and well-understood by employees, and there are many reasons why you would consider them. An RSU is a type of stock-based compensation that grants an employee a certain number of shares of company stock, which they automatically receive once vesting conditions (generally time-based) have been satisfied.

On the other hand, NSOs and ISOs are options that give employees the right to purchase company shares at a predetermined price after a vesting period. 

Here are the key differences between NSOs, ISOs and RSUs.

Tax treatment

• ISOs: No tax is due at the time of grant, and there is generally no tax owing at exercise (when the options convert into shares). However, in some circumstances alternative minimum tax (AMT) may be payable upon exercise. The entire gain will be taxed when the shares are sold (unless AMT was paid at exercise).
• NSOs: No tax is due at the time of grant. The difference between the exercise price and the fair market value of the stock at the time of exercise will be taxed on exercise. When the shares are ultimately sold, the difference between the fair market value (FMV) at exercise and the sale price will be taxed.
• RSUs: No tax is due at the time of grant. The full FMV of the shares is taxed when the RSUs vest and the employee receives unrestricted ownership of the shares. When the shares are sold, the difference between FMV at vesting and the sale price will also be taxed. 

Eligible recipients

• ISOs: Can only be granted to employees. 
• NSOs: Can be granted to employees, directors, consultants and other service providers.
• RSUs: Can be granted to employees, directors, and other service providers. 

Conditions and Restrictions

• ISOs: Must meet several requirements to qualify for favourable tax treatment, including an accelerated exercise period (employees must exercise options within3months of leaving a company), minimum holding periods, and limits on the exercise price and term. A total value of options can become exercisable in a given year as ISOs ($100,000/employee).
• NSOs: Have fewer restrictions than ISOs, and the company can determine most terms (including the exercise period and transfer restrictions).
• RSUs: Don’t have the same exercise price and term restrictions as options, but the shares are subject to vesting conditions.

NSOs vs ISOs vs RSUs

To summarise, ISOs offer the most favourable tax treatment for staff but are the most complicated to offer and administer, with numerous conditions and restrictions. NSOs provide more flexibility than ISOs but are subject to reasonably standard income tax. RSUs are less flexible but avoid the complexities of options and still provide equity incentives. 

Many US companies grant ISOs, and employees expect you to do so because of the favourable tax treatment available. However, complying with the conditions of ISOs can be difficult for your company if you’re operating a multi-jurisdictional ESOP.    

NSOs are good for aligning terms (particularly exercise periods) across geographies, as employees can hold their options without exercising them even if they're no longer with the company. 

RSUs are reasonably good for aligning terms across jurisdictions. They can be useful in stretching your employee incentive pool further, as at the time of grant, you're giving more value to employees, as there's no exercise price that employees need to pay to receive their shares so that you can issue fewer RSUs. The tax treatment of RSUs can be complex for employees; however, double triggers can help reduce this burden. Typically, tax is payable on exercise with RSUs. But if you have a double trigger, with the second trigger being an exit, it pushes the tax payment to the exit (which is where you want it). 

If you determine that NSOs or RSUs are more suitable for your plan, clear communication with US employees is fundamental to explaining why you're issuing NSOs or RSUs and the benefits to employees.

Administering ESOP plans in the US with an Australian TopCo

If you have an Australian TopCo and only have a small team working on ESOP, Rosanna stresses the importance of keeping plans as consistent as possible across geographies and team members to avoid the administrative difficulties of having multiple plans. It's also important to properly manage your US sub plan to ensure you don't tip over the 50 shareholder limit and subject yourself to additional compliance and takeover burdens in Australia.

If you’ve aligned your plan across geographies, you’ll likely use standard terms like a one-year cliff with a total four-year vesting schedule. You'll need to discuss with employees why exercise doesn't align with the vesting schedule but, rather, an exit event.

Having a comprehensive FAQ drawn up helps ensure everyone understands the plan's details and feels confident discussing it. It's also essential for internally driving alignment and clarity on terminology and comms strategies.  

Valuation

The Internal Revenue Service (IRS) requires a 409A valuation annually to assess the value of common shares given to employees. For a privately-held company, the 409A valuation is essential for tax-free option grants to employees. 

Disclosure requirements

Normally, companies issuing equity in the US need to comply with disclosure requirements, meaning they have to provide documents disclosing key information about the company to investors. However, there are several exemptions to these disclosure requirements for ESOPs. If your startup is reasonably small, it would generally satisfy one of these exemptions, but it's essential to get local advice (legal and/or accounting) to confirm if your company has any disclosure obligations.

UK 🇬🇧

Given the similarities between the Australian and UK legal systems, can you use theT&Csfrom your Australian ESOP plan in the UK?

“Yes and no,” says Jason. “If you’ve got an Australian TopCo, you don’t need a separate plan; changes can be covered in an addendum.”

Types of ESOP schemes in the UK

The UK offers 4 types of employee incentive schemes that have beneficial tax treatment: 

1. Share incentive plans (SIPs): Under SIPs, your company issues shares to employees (rather than options). There are several different versions of SIPs:
   • Free shares: Companies give employees free shares.
   • Partnership shares: Employees can buy shares out of their salary before tax deductions.
   • Matching shares: Companies can give employees matching shares for each partnership share they buy. 
   • Dividend shares: Companies can allow employees to buy more shares with the dividends they receive from free, partnership, or matching shares.
2. Save as you earn option schemes (SAYE): Eligible employees are issued options and have a portion of their salary paid into a separate savings account for a fixed period (generally 3 or 5 years). At the end of the period, the employees can elect to use the sum in their savings account to exercise the options, or they can withdraw the savings. 
3. Company share option plan (CSOP): A discretionary share option plan under which a company may grant options to any employee or full-time director. 
4. Enterprise management incentives (EMI): A government-backed, tax-advantageous share option scheme. 

Tax treatment

• SIPs: For free, partnership and matching shares, income tax is payable if the employee takes shares from the plan within the first 5 years. If they leave the shares in the plan, they get the full tax benefit when they sell them. Employees won't pay tax for dividend shares if they keep them for at least 3 years. 
• SAYE: The interest and any bonus at the end of the scheme are tax-free. However, employees may have to pay Capital Gains Tax if they sell the shares.  
• CSOP: Participants have the option to buy shares at a non-discounted price, with tax implications upon exercise and sale. Any gain made by the individual is only exempt from income tax if the options are held for at least 3 years. 
• EMI: Employees don't pay income tax or national insurance if they buy the shares for at least the market value when they are granted the option. They may have to pay capital gains tax if they sell the shares.  

Eligible recipients

• SIPs: Must be offered to all employees on the same terms.
• SAYE: Must be offered to all employees with 5 years’ service or more and may be offered to employees with less service.
• CSOP: Granted on a discretionary basis to any employee or full-time director of the establishing company. 
• EMI: Participating employees are required to work for the company for at least 25 hours a week or, if less, at least 75% of their working time. 

Restrictions

• SIPs: 
  • Free shares: Companies can give up to £3,600 of free shares in any tax year
  • Partnership shares: The number of shares an employee can buy out of their salary is capped at £1,800 or 10% of their income for the tax year. 
  • Matching shares: Companies can give up to 2 free matching shares for each partnership share the employee buys. 
  • Dividend shares: Employees can use up to £1,500 of plan dividends in this way in any tax year. 
• SAYE: Employees can save up to £500 a month under the scheme. 
• CSOP: Options must be granted at market value and each employee can only be granted up to £60,000 of options. 
• EMI: To offer EMIs, the company must have fewer than 250 full-time employees and assets worth £30 million or less. Companies can grant shares up to the value of £250,000/employee in a 3-year period. EMIs also require an HMRC-approved valuation, and the company can only use that valuation to issue options for 90 days. 

SIPS vs SAYE vs CSOP vs EMI

About 85% of companies in the UK use EMI. 

“It’s the best balance of all the different variables if you want to keep things as simple as possible,” says Jason. “You want as much flexibility of when the taxation event occurs, how much equity you can issue to someone within a year, and when they need to exercise.”

With EMI, you can issue ~4 times the number of options over three years than under the CSOP scheme. However, companies with over 250 employees typically use the CSOP scheme because it caters to bigger entities.  

The various SIP regimes are tax-advantaged programs (similar to RSUs in the US) that can offer zero tax rates. However, they must be offered to all employees and have low limits on the number of shares you can issue.

Administering ESOP plans in the UK with an Australian TopCo

You’ll need to have a trading entity in the UK before you can get started with your ESOP plan, which means you will have to prepare a cap table. 

Valuation

If you’re issuing equity under a HMRC-approved scheme (SIPs, SAYE, CSOP and EMI), it’s recommended you obtain a HMRC-approved valuation (and you must obtain a HMRC-approved valuation for EMIs). The HMRC valuation primarily focuses on determining the fair market value of assets, while the Australian NTA approach focuses on assessing the net tangible asset value of a business entity. 

Parting advice

• Advocate for having a highly standardised scheme globally to minimise the risk of internal issues. Our friends at Cake can help you out on that front. If you have different rules in each country, you'll likely come to a grinding halt over the admin burden. 
• Develop an internal policy for allocating equity. Grading scales are popular, for example:
  • Regular team members: 10% on top of their salary
  • Heads and leads: 20% on top of their salary
  • Execs: 50% of their salary
• Employees have different expectations regarding ESOP in different countries, which you'll need to consider.
• Communication is key–you want employees to understand their equity so they value it. Otherwise you’re giving away 10% of your company for no benefit. 

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This article contains general information only and does not constitute legal, financial or tax advice, nor does it take into account your personal circumstances. You should always seek independent professional advice before acting on any information in this article.