Employees are the bedrock of every company’s operation. Employee stock option schemes, employee share option schemes (“ESOS”) or employee share option plans (“ESOP”) have been adopted by many companies including start-ups as part of their strategy to attract and retain employees and align the goals and objectives between the company and employees. This form of compensation is not just limited to employees at the executive level, but also at the working-level.

Based on our experience, there are three common types of equity-linked employee compensation adopted by companies in Singapore:

1. ESOS / ESOP – Employees are awarded share options that give them the right, but not the obligation to purchase the shares of the company at a pre-determined price and date, regardless of the future price of the company’s share. 

2. Performance Share Plan (“PSP”) or Restricted Stock Units (“RSU”) – Employees are awarded shares of the company upon achieving certain requirements or milestones (e.g., achieving financial KPIs such as a sales/ EBITDA target, or attaining a specified share price, or based on performance of the company’s share price relative to an index). However, the awarded shares could be subject to moratorium periods.

3. Phantom Share Plan – Employees are awarded a cash bonus based on the increase in the company’s share price during a pre-determined period. The share price could be determined based on a pre-determined formula based on a particular financial measure of the company.

Due to its flexibility, the most common employee incentive plan adopted is the ESOS / ESOP, especially among start-ups. To establish an ESOP, an employer needs to consider the following:

1. Option award amount – The number of share options allotted to employees.

2. Vesting condition – The condition that determines whether the company receives the services that entitle the employee to receive the share options. These conditions are either a service condition (i.e. a specified period of service during which services are to be provided by the employee) or a performance condition (i.e. where a specified performance target(s) to be met while the employee is in service)

3. Exercise price – Price per share which the employee has the right to buy the company’s share for.

4. Tenure of the option – The period in which employees are permitted to exercise the share options.

5. Other option award terms – e.g., moratorium periods on the underlying shares.

On many occasions, we have encountered clients overlooking the fact that prevailing accounting standards (i.e. Singapore Financial Reporting Standards 102 Share-based Payment (“FRS 102”), Singapore Financial Reporting Standards (International) 2 Share-based Payment (“SFRS(I) 2”),  International Financial Reporting Standards 2 Share-based Payment (“IFRS 2”) and Accounting Standards Codification 718 Compensation-Stock Compensation (“ASC 718”)) require share compensation to be accounted for as expenses on their financial statements. 

Based on our experience with various clients and auditors, the commonly accepted methods to measure the fair value of these financial instruments are as follows:

1. Black-Scholes Model (“BSM”) – A commonly adopted option pricing model, referenced in prevailing accounting standards, to determine the fair value of employee share option is the BSM. It is a stochastic differential equation that determines the fair value of the employee share option by considering its exercise price, tenure, company's current share price, interest rate, and volatility of the company's share price. This model is commonly adopted for employee share options that can only be exercised upon expiration.

2. Binomial Model (“BM”) – An iterative method that values employee share option using multiple periods along a range of possible results for each period. Commonly adopted for employee share options that can be exercised anytime.

3. Monte Carlo Simulation (“MCS”) – A scenario-based valuation method that involves modeling scenarios of possible outcomes to derive a probability-weighted outcome to determine the fair value of the employee share option. Commonly adopted when the employee share option contains multiple sources of uncertainty or with complicated features.