Commonly Used Terms: A Comprehensive Explanation for Employees and Employers

ESOP: An Opportunity for Employees to Become Owners

What is an Employee Stock Ownership Plan (ESOP)?

ESOP stands for Employee Stock Ownership Plan or Employee Stock Option Plan. It is a plan that rewards employees with a (possible) interest in the company. It is often used by companies that do not have enough liquid assets to offer competitive salaries or compensation. Additionally, companies often use ESOPs to retain key personnel, as most ESOPs have a vesting schedule.

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What is an Employee Participation Plan (EPP)?

EPP can be seen as a synonym for ESOP. Both plans aim to give employees a share in the company.

Vesting: How and When Do You Benefit?

What is vesting?

Vesting refers to the process by which an employee gradually acquires ownership of shares, options, or other assets over a certain period or after achieving specific goals. As time passes or milestones are achieved, a portion of the assets "vests." A typical example is a four-year vesting schedule where the employee vests 25% of the assets each year.

What is time-based vesting?

This is vesting based on a predetermined period, such as monthly, quarterly, or annually.

What is milestone-based vesting?

This type of vesting is based on achieving specific milestones, such as reaching individual goals or completing assigned projects.

What is hybrid vesting?

As the name suggests, hybrid vesting is a combination of time-based and milestone-based vesting.

What is reversed vesting?

In reversed vesting, assets like shares are given directly to the employee, but with an agreement that rights to these assets vest gradually over time. If an employee leaves the company before the vesting period is completed, the employee must return non-vested assets or the company may buy them back.

What is a cliff?

A cliff is a type of "probation period" before the actual vesting schedule begins. In the Netherlands, this is often set at one year.

Additional Concepts Around ESOP

What are certificates (depositary receipts)?

Certificates are issued by a STAK (Foundation Administration Office) after it receives the shares of a company. This allows employees to benefit from an ESOP without becoming a direct shareholder.

What does "exercising an option" mean?

This refers to the exercise of the right to convert an option into shares or certificates of a company.

What is a liquidity event?

A liquidity event is a significant occurrence, such as the sale of a large portion of a company's shares or an IPO. In many ESOPs, this leads to full vesting of shares or options.

What is a clawback?

This is a clause that can require employees to repay received proceeds to the company under certain circumstances, such as misconduct.

What are leaver arrangements?

These are agreements regarding what happens to an employee's assets if they leave the company. There are good leaver and bad leaver arrangements, depending on the reason for departure.

What are drag along and tag along clauses?

A drag along forces remaining shareholders to offer their shares when the majority of shares are sold. A tag along gives minority shareholders the right to include their shares in a sale offer made by a larger shareholder.

Conclusion

Offering shares and options to employees through ESOPs and related arrangements can be a powerful tool for attracting and retaining talent. By understanding the various concepts and clauses, both employees and employers can make better-informed decisions and maximize the benefits of these arrangements.