Disclaimer
This article is intended to assist business owners in understanding ESOP structures. As we are not tax experts, the information provided is for general informational purposes only and does not constitute tax advice. Readers are advised to seek professional advice from a tax expert before making any decisions.An Employee Share Option Plan / Scheme (ESOP / ESOS) gives selected employees the right to acquire shares in the company at a future date, at a price fixed in advance.
It is one of the most common strategies by startups and other private companies in Malaysia to attract and retain key talent, and in this guide for founders, we cover:
- why founders use an ESOP
- how it works in a Malaysian private company, and
- key terms that typically make up a scheme
Let’s begin.
Why companies use an ESOP
An ESOP is most commonly used by early-stage startups in order to:
- attract senior hires who expect an equity component alongside salary
- retain key employees over a multi-year vesting period, rather than through salary alone
- conserve cash by offering upside instead of higher current compensation
- align employee incentives with the company’s growth and eventual exit
Of course, it can still be used by companies at any growth stage, so long as they have determined that offering an ESOP is a more beneficial strategy than offering a higher salary.
Two ways to structure an ESOP
Depending on the structure adopted, it affects which Companies Act 2016 (CA 2016) provisions apply and how the scheme shows up on the cap table.
| Model A: option over unissued shares | Model B: transfer of existing shares | |
| What is transferred | An option over shares the company has not yet issued | A slice of existing shares an existing shareholder, often the founder, already holds |
| New shares issued? | Yes, new shares are allotted to the employee on exercise | No, existing shares are transferred rather than newly issued |
| Governing CA 2016 provisions | Shareholders’ resolution to approve the allotment of shares should be obtained under section 75 before the directors exercise any power to allot new shares Section 129 requires the company to maintain a register of options over unissued shares | Share transfer provisions under section 105 |
| Cap table impact | Dilutes all existing shareholders once the new shares are allotted | Dilutes only the shareholder whose shares are set aside, until those shares are transferred |
| Pre-emption Rights | May be subject to shareholders’ pre-emption rights on the issue of new shares under section 85 of the Companies Act 2016, as modified by the company’s constitution and/or shareholders’ agreement Waivers or approvals may be required where such rights apply | May be subject to transfer restrictions and/or pre-emption rights on share transfers under the company’s constitution and/or shareholders’ agreement Waivers or approvals may be required where such rights apply |
Depending on circumstances, a company can also combine the two for different groups of employees. The rest of this guide applies to either model unless stated otherwise.
How an ESOP works in a private company
Although every ESOP is drafted differently, most private companies follow the same overall process:
- Employees are granted options
- Those options vest over time or upon meeting certain milestones, and
- They only become shares if the employee chooses to exercise them
As the section above covered, an ESOP can be structured such that shares come from an existing shareholder, be newly issued by the company, or a mix of both, and the sections below explain key considerations about how a typical private company ESOP plays out.
Options are not shares
Until an employee exercises their option and pays the exercise price, they hold no shareholding, voting rights, or dividend entitlement in the company.
Using a trust or nominee shareholder (Model B)
Some companies add a trust or nominee arrangement under Model B, where the founder declares that part of their existing shareholding is held on trust as the ESOP pool. The trust deed governs how those shares are allocated to employees as options vest and are exercised. to employees as options vest and are exercised.
Until the shares are transferred into the employee’s own name, the founder remains the registered shareholder of those shares, while the employee enjoys the beneficial interest in accordance with the trust arrangement. This avoids frequent changes to the company’s share register and can make the ESOP easier to administer.
Business owners should also consider whether any beneficial ownership reporting obligations arise (i.e, if the employee’s beneficial ownership is more than 20%). For more information, see our article on Beneficial Ownership Declaration.
What employees should know before accepting an ESOP
From the employee’s perspective, an ESOP is not a guaranteed benefit. It gives potential upside if the company grows, but the shares are usually illiquid until an exit, and the value of the option can be zero if the company does not perform.
Employees should treat an ESOP as a long-term incentive, not a cash equivalent.
Where the ESOP share pool can come from
The share pool set aside for an ESOP does not have to come from the founder alone. In practice, a company can build the pool in a few ways:
- Existing shareholders transferring part of their shares into the pool, often in proportion to their existing shareholding (Model B).
- The founder setting aside part of their shareholding, which is common in early-stage companies before other shareholders are involved (Model B).
- The company reserving shares for future issue, which are only allotted when options are actually exercised, diluting all existing shareholders rather than just the founder (Model A).
When a trust-based ESOP works best
A trust structure generally suits schemes offered across a class of employees, while for a single key hire, some companies instead use a share award letter, which is more individualised and tailored to that specific hire, and for a closer look see our ESOP vs employee share award letter comparison.
Key ESOP terms
Before setting up a scheme, it helps to see the key terms an ESOP typically covers, summarised below.
| Term | What It Covers |
| Eligibility | Which employees qualify for the scheme, and whether it is offered to a class of employees or negotiated on a case-by-case basis |
| Grant date | The date on which an option is formally granted to an employee. Vesting and exercise periods are usually calculated from this date. |
| Exercise price | The price an employee pays to convert an option into shares, structured as nil-cost, market value, or a discount to market value |
| Vesting schedule | The period and conditions an employee must satisfy before an option can be exercised |
| Exercise window | When a vested option can actually be exercised, which some schemes tie to an anticipated sale or listing, and others leave open once vesting is complete |
| Scheme duration / long stop date | The overall lifespan of the scheme, and the final date by which a vested option must be exercised before it lapses (e.g., 6-10 years) |
| Lapse and leaver provisions | What happens to unvested and vested options when an employee resigns, is terminated, or otherwise leaves |
| Company powers | The company’s ability to terminate the scheme, compulsorily acquire options, or claw back options in certain circumstances |
If you have an idea on the model you wish to adopt, the next question is how to implement it and structure the mechanics, which we cover in our article on setting up an ESOP.
Let ELP structure your ESOP
A well-drafted ESOP should do more than allocate equity. It should provide a clear framework for how options are granted, exercised, and managed throughout the company’s growth, while remaining flexible enough to accommodate future fundraising and employee hires.
We advise founders on designing ESOPs that balance employee incentives, founder control, and investor expectations, and assist with the full suite of ESOP documentation. Contact us for an initial consultation.
