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.Founders looking to give employees equity in a private company can choose from two of the most common structures:
- an Employee Share Option Plan (ESOP) offered as a scheme to a class of employees
- a share award letter negotiated individually with a single employee
This article compares the two structures side by side and sets out how to decide which one fits a given hire or company stage.
Two different starting points
An ESOP is a scheme that is set up once and governed by its own rules. The rules apply consistently to whichever employees are later granted options under it. It gives employees an option to acquire shares in future, not the shares themselves. For further details on the mechanics, see our guide to setting up an ESOP.
A share award letter is a one-off contractual arrangement that documents the terms on which a specific employee is awarded shares directly, without setting up a scheme for future hires. It grants the key employee shares once specific milestones are achieved by the employee, typically on a gradual basis. The shares may vest based on one or both of the following mechanisms:
- Performance-based vesting: the employee becomes entitled to the shares upon achieving specified performance targets or business milestones.
- Time-based vesting: the employee becomes entitled to the shares after remaining employed for a specified period (e.g. over three years), typically with vesting occurring in stages.
Once the applicable vesting conditions are satisfied, the shares are transferred or issued to the employee in accordance with the terms of the share award letter.
Comparison at a glance
The table below summarises the key practical differences between the two.
| ESOP | Share Award Letter | |
| Who it is for | A class of employees, such as all senior management or all confirmed staff | One or few specific employees, negotiated individually |
| Governing document | A scheme with its own rules or by-laws, applied consistently across participants | A single contractual letter or agreement between the company and that employee |
| What is awarded | An option to acquire shares in future, at a price fixed in advance | Shares issued or transferred directly, subject to agreed conditions |
| Vesting and conditions | Set out in the scheme rules, applied uniformly to all participants | Individually negotiated, and can be tailored to the specific hire |
| Set-up effort | Higher upfront cost and documentation, since the scheme needs to work for multiple future participants | Lower upfront cost, since only one arrangement is being documented at a time |
| Best suited for | Companies planning to grant equity to employees on an ongoing basis, or preparing for fundraising | A one-off award to key hires, without setting up a company-wide programme |
Can the share award be included in the employment contract?
Yes, but not recommended, as the employment relationship and the employee’s equity rights should ideally remain distinct.
An employment contract governs the employee’s duties, salary, benefits, working hours, and termination of employment. A share award, on the other hand, governs matters such as vesting, transfer restrictions, leaver provisions, forfeiture, and other shareholder-related rights and obligations.
Keeping these documents separate has several advantages:
- Clear separation of legal relationships: The employment contract governs the employment relationship, while the Share Award Letter governs the employee’s equity rights. Keeping them separate ensures that each operates independently.
- Independent administration: Changes to the share award (for example, vesting, forfeiture or cancellation) can be made without amending the employment contract, and changes to employment terms likewise do not require the equity documentation to be updated.
- Keeps each document focused: Each document serves a distinct purpose, making them easier for both the company and employee to understand, administer and update.
So while it is possible to include share award provisions in an employment contract, it is usually better to document the arrangement in a separate share award letter.
In practice, the employment contract can simply state that the employee may be granted equity under the company’s share incentive plan, with the detailed terms set out in a separate share award letter.
Choosing between the two
The right structure usually comes down to how many people are involved, and whether this is a one-off arrangement or the start of an ongoing practice.
- if the company expects to grant equity to employees more than once, setting up an ESOP upfront avoids repeating the same negotiation for every future hire
- for a tailored award to one key hire with no immediate plans for a broader programme, a share award letter achieves the same commercial outcome with less upfront documentation
A company is not limited to one or the other and can use a share award letter for an early key hire and adopt an ESOP later as the company scales and hiring becomes more structured.
Whichever option is chosen, it will involve changes to the company’s shareholding structure, and it is important to ensure the terms align with the Shareholders’ Agreement and company constitution.
Let ELP draft your ESOP or share award documentation
Whether your company needs a full ESOP, a single share award letter, or a mix of both over time, we can advise on the most suitable structure for your company and prepare the relevant scheme rules, award letters, or supporting documentation. Contact us for an initial consultation.
