STOCK OPTION PLANS FOR EMPLOYEES AND GUIDELINE IN SEVEN QUESTIONS
It is undisputed that the software industry became one of the most popular scopes of activities, in today’s world. Indeed, start-ups operating all around the world usually make dramatic progress in very short period and exponentially increase the company’s value, by selling the company or constantly making high profits. As a natural result of such success, value of the company stocks increases and, in this way, stockholders get profit.
Mentioned characteristics of the Start-ups require the exercise of Stock Option Plans, because companies which are growing or planning to improve their business are in constant competition with each other, for hiring and retaining qualified employees and increasing their motivation. Especially, considering that paying high salaries to employees before the exit may not be possible, employees may decide to evaluate other job opportunities, Stock Option Plans provides way out both for employees and companies.
However, since Stock Option Plans are related with law fields such as Corporate Law, Labor Law, Contracts Law and Tax Law, employees usually face with difficulties regarding the apprehend the legal consequences and characteristics of the Stock Option Plans which are proposed to them. On the other hand, since Stock Option Plans are relatively new in Turkey, not regulated by law, and are rarely mentioned in court decisions, it is hard to have research regarding the Employee Stock Option Plans in Turkish Law. In this research, we will be focusing on the details which Employees who received a Stock Option proposal should be careful on.
1. Does Stock Option Plans Burden Employees with any Obligations?
Firstly, we should clarify that main function of Stock Option Plans are submitting an option to Employee, as it can be understood from its name. Mentioned option entitles Employee to buy specific number of company stocks, after working for a specific term in the company (“vesting period”) and against the stock value (“strike price”) at the signing date of the Stock Option Plan.
If company raise in value during the vesting period, since Employee will have a right to buy the optioned stocks on previous (signing date of the Stock Option Plans) value, Employee will make profit at the rate of growth and number of optioned company stocks.
In addition, in case where stock value decreases because company does not raise in value, or some other reason, Employee is entitled not to use the provided option right and not to buy the stocks offered through the option. In this regard, it should be stated that even if stocks do not gain value, Employee will not be burdened with any kind of responsibility.
Put it differently, with involving to the Stock Option Plans, Employee will not be burdened with other obligations. Besides, Employee has a right to leave the job before the ending of vesting period or terminate the contract or may resign from the job or may choose not to buy the offered stock by not exercising the option, as it is stated above.
2. Signing Parties of the Stock Option Plans
In according to foreign practices, principally, Stock Option Plans should be signed between Employee and Company that owns the stocks which are subjected to option. Nevertheless, since Joint Stock Companies has restrictions to acquire their own shares in Turkish Law, Stock Option Plans are usually signed between Employee and shareholders of the Company.
In this point, we should focus on the legal situation where company stockholders are changed (“change in control”) before the exercise date of the option. As it is already known, in accordance with the principle of “Privity of Contracts”, agreements constitute bindingness only between the signing parties of the contract, in principle. Accordingly, in case where Stock Option Plan is signed between Employee and current shareholders, Employee will have a right to assert claims arising from the contract, only against shareholders which are the signing party of the contract, and not to the company. If stockholders who are the signing party of the contract, transfers all of their shares to the third parties, in legal perspective, it will be impossible for Employee to buy the company stocks. Even tough Employee will have a right to assert claims against the previous shareholders for the compensation of damages, will not be entitled to buy the company stocks and be a stockholder of the company.
In order to prevent this problem, it will be appropriate to sign the Stock Option Plan between Employee and Company and conducting the transfer of the new stocks which will be issued by the capital increase.
3. How to Calculate the Stock Value?
Another issue that we should focus on is the method of calculating the value of stocks which are subjected to option. Because as it is explained above, for Employee to be able to calculate the profit rate in case of the exercise of the option, Employee should precisely know the stock price at the signing date of Stock Option Plan and exercise date.
Since stock prices cannot be calculated instantly on companies which are not publicly traded, it is impossible for employees to obtain such information through their own efforts. Besides, information provided by the company representatives may not be accurate enough. For the resolution of such problem, valuation of the company should be conducted by an independent audit company and stock price at the evaluation date (“fair market value”) should be calculated. In this way Employee will have a chance to act according to reports of independent audit company and will be able to make more accurate decision regarding the exercise of the option.
4. Is it possible to Provide Stock Option Plans Without Fee?
As it is explained above, Employee who is granted with option, shall pay the value of shares at the signing date of Stock Option Plan to the Company if decides to exercise the option which is granted to him.
The reason of imposing such obligation is arising from the necessity of protecting the employees which are participated to Stock Option Plan at the earlier date. To explain this with an example, while an employee who participated to Stock Option Plan at the year 2014 will be liable to pay the 2014 value of granted shares, an employee who participated to Stock Option Plan at the year 2018 will be liable to pay the 2018 value of granted shares. Since companies are expected to gain value each year considering the structure of Stock Option Plan, employees participated to Stock Option Plans at earlier date will be entitled to take over the shares by paying lower fee.
If Stock Option Plan is designed without compensation, participation date of employees will not have any kind of importance, because when exercise date is due, employees will not have any obligation of payment. This may constitute problems regarding the rights of current partners and that’s why Stock Option Plans are usually designed with compensation.
Also, it should be marked that, if Stock Option Plans are formed with compensation, Employees will be obliged to make a payment to company for exercising the option, even if it is lower than the actual value. Thus Company will be taken an investment by share sale.
In practice, in order to protect the employees who are included in Stock Option Plan, usually, the fee that shall be paid for taking over the stocks would be split into installments or can be agreed to be paid in long terms such as five years.
In addition to explanations stated above, surely there are not any kind of legal obstacles to form the Stock Option Plans without compensation. If agreed by the Parties, Employees may be granted with shares without compensation.
5. Type of Stocks Which are Subjected to Option
In principle, if not stated otherwise in the articles of association, all stocks grant equal rights to their owners. On the other hand, in some cases, thanks to article 478/2 of the Turkish Commercial Code (“TTK”) companies may choose to grant privileges to some of the stocks, regarding the issues such as dividend rights, voting rights, liquidation share, and etc.
If there are stocks with different type of privileges, these stocks would be categorized with different group names (Group A Stock, Group B Stock, Group C Stock etc.). In this respect, stocks which provides privileges to owner would be named as “preferred stocks” and others as “common stocks”.
In this case, it is significantly important for Employee to learn the types of stocks that are subjected to option and decide to exercise or not to exercise the option in the light of these information.
6. Relationship Between Employment Contract and Stock Option Plan
As known, pursuant to employment contract signed between employee and company, employment relation between parties would be formed and might be terminated with the notice of one party. Besides, if employment contract is terminated by company, or by employee with right cause, fate of the stock options granted to employee would be disputatious.
First of all, pursuant to article 61 of 193 numbered Income Tax Code, profit made by the sale of stocks, which are granted to employee by company will be accepted as labor wage. Likewise, in the mentioned article it is stated that “Labor wage is an interest that can be monetised and provided as money or asset to Employees which are working as depended to company or employer, in return of their services.” Thus, even if, at the signing date of employment contract it is unclear that option will be exercised or not, all benefits provided to Employee through Stock Option Plans are accepted as labor wage in Turkish Law.
If stocks will be transferred to Employee without any fee, full value of the stocks, or if stocks will be transferred to Employee against fee, difference between full value of the stocks at the transfer date and fee that will be paid by the employee will be accepted as labor wage.
Stock Option Plans, in accordance with their legal characteristics, shall be accepted as an integral part of the Employment Contracts, and if mentioned contract is terminated because of any reason, shall be terminated automatically. In case of termination, in principle, it is accepted that Employee is entitled to claim only the shares which are vested before the termination date. Still and all, especially when contract is annulled by Employer and without cause or when reinstatement claims arise, it is unclear if Employee would be entitled to claim the stock options which are not vested yet.
We believe and foresee that the uncertainty about this issue will be cleared through growing popularity of Stock Option Plans and there will be more court decisions regarding this matter.
7. Taxation
As it is stated above, all savings paid to employees which are working depended on the employer or company, in return of their services, are accepted as labor wage. Providing the mentioned savings as money, asset, real estate or stocks to employee will not make any difference. In this respect, it is beyond dispute that stock options granted to employee shall be attributed as labor wage.
Another issue to be noted at this point is that the stocks which are transferred to the Employees under the Stock Option Plans should be taxed only at the rate of the benefit obtained by the Employee.
This benefit would be subjected to withholding tax and shall be declared by employer in the withholding tax statement. Also, in accordance with the amount of benefit obtained by the employee, tax rate which will be imposed pursuant to article 103 of Income Tax Code will be calculated.
