ESOP Set Up: Exercise Terms, Company Powers & Documentation

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. 

Being a fairly expansive topic, we have published several guides on it and readers new to the concept may want to start with our complete guide to ESOPs as this article assumes a foundational understanding and focuses on what goes into setting one up, including:  

• how the exercise price and vesting work 
• when options can be exercised 
• the powers a company typically retains over the scheme 
• how implementation runs in practice, and  
• documents needed to put it in place 

Let’s begin. 

Exercise price and vesting 

The exercise price is the amount an employee pays to convert a vested option into shares. Three structures are commonly used: 

1. Nil-cost options, where no payment is required on exercise. 
2. Market value options, priced at the fair value of the shares at the time the option is granted. For private companies, market value is usually set by reference to the last funding round price, net tangible asset value (NTA) or an independent valuation conducted by a financial valuer. See also our article on common company valuation methods. 
3. Discounted options, priced below market value as an added incentive. 

The price fixed at grant generally stays fixed. If the company’s value increases significantly by the time the option is exercised, the employee still pays the original price, and the difference becomes their gain. 

The tax treatment of an option depends on the structure chosen and the timing of grant and exercise and should be confirmed with a tax adviser before the scheme is finalised. 

Vesting refers to the period and conditions an employee must satisfy before an option can be exercised. A cliff period is commonly included, whereby there will be no vesting in the first year, followed by a time-based schedule, such as monthly or annual vesting over three to four years. Some companies also apply performance-based vesting, tied to individual or company targets. 

When employees can exercise their ESOP options 

Vesting and exercise are not the same thing, and how a scheme links the two is a design choice rather than a fixed rule. 

Some schemes only allow exercise once a sale, listing, or winding up of the company is imminent or has occurred. This keeps the cap table stable until an actual exit event and avoids bringing in new shareholders or triggering a share transfer before a liquidity event occurs.  

Other schemes allow exercise at any time once an option has vested, regardless of whether an exit is on the horizon. This gives employees earlier access to real shares but means the company should be ready to issue or transfer shares. A scheme duration or long stop date may also be fixed, after which any unexercised vested option lapses. 

Founders should decide which fits their company when the scheme is first drafted, rather than leaving it to be worked out later.  

The company’s powers  

Ultimately, an ESOP is a plan approved by the company to benefit its employees, and accordingly it is common for the company to retain large discretion and powers over the administration of the scheme, including: 

• terminating the scheme without needing employee consent 
• compulsorily acquiring vested or unvested options upon certain trigger events 
• requiring option holders to participate in a drag-along on a sale of the company, so the sale can proceed without individual holdout 
• clawing back options already granted, typically where an employee is terminated for cause or found to have committed misconduct 

These powers are not unlimited; their purpose is to ensure the ESOP does not obstruct the company’s restructuring or exit plans. To ensure proper governance, the specific triggers and mechanics should be properly documented to avoid disputes.  

How an ESOP is implemented 

Once a company decides to proceed, implementation typically follows a similar sequence regardless of which model is used as covered in our guide to ESOPs: 

• design the scheme, including pool size, eligibility, exercise price, and vesting. 
• obtain board approval, and shareholder approval where required by the constitution or a Shareholders’ Agreement. 
• adopt the ESOP rules or by-laws governing the scheme. 
• grant options to selected employees. 
• vesting runs over the agreed schedule. 
• employees exercise vested options, where the scheme’s exercise conditions are met. 
• shares are issued or transferred, and the register of members is updated accordingly. 

Considerations before setting one up 

Setting up an ESOP involves more than fixing an exercise price and a vesting period. Founders should also think through: 

1. Pool sizing, since a larger pool dilutes existing shareholders more, while a pool that is too small may limit the company’s ability to make further grants later. In practice, ESOP pools in Malaysian private companies are commonly sized at around 10% to 20% of the company’s share capital, though this varies by company and funding stage. 
2. Eligibility criteria, including whether the scheme applies to all employees, a specific level of seniority, or is granted on a case-by-case basis. 
3. Leaver and lapse provisions, particularly whether unvested options lapse automatically on resignation, and whether exceptions apply for retirement, retrenchment, or ill health. 
4. The documentation needed to implement the scheme, which differs depending on which model is used, set out below. 

Because an ESOP is highly customisable, these points are usually worked through with legal input rather than adopted from a generic template. 

Document checklist by model 

The documents needed to put a scheme in place follow the structure of the model used, as set out below. 

Model A: Option over unissued shares

Model B: Transfer of existing shares

ESOP rules or by-laws Board and shareholders’ resolutions approving the scheme Offer or grant letter to each employee Acceptance letter from the employee Register of options under Section 129 of the Companies Act 2016 Exercise notice or subscription form Return of allotment (Section 78) lodged with SSM Updated register of members

ESOP rules or side letter Board resolution approving the arrangement Offer or grant letter to each employee Acceptance letter from the employee Share transfer documentation, such as an instrument of transfer or share sale agreement, depending on the structure Trust deed, if a trustee structure is used Deed of adherence, if an existing shareholders’ agreement requires it Updated register of members

Let ELP structure your ESOP 

We advise founders on structuring ESOPs that balance employee incentives with founder control and investor expectations and prepare the complete set of documentation needed to implement and administer the scheme. Contact us for an initial consultation.