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.
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.
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.
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.
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 alsoimportantto 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.
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.
Normally, companies issuing equity in the US need to comply with disclosure requirements, meaning they have to provide documents disclosingkeyinformation 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'sessential to get local advice (legal and/or accounting) to confirm if your company has any disclosure obligations.
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.”
The UK offers 4 types of employee incentive schemes that have beneficial tax treatment:
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.
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.
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.
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.