Issuing Share Options and Warrants in Singapore
Many Small and Medium Enterprises (SMEs) are incorporated as private companies limited by shares.
If you are the owner of an SME, did you know that not only can you issue shares, or even different classes of shares, but you can issue share options and warrants too? These are yet another avenue for SME owners to raise capital through equity and related derivatives for business development and also to reward loyal employees.
What are Share Options?
A share option is a contract between two parties.
Imagine A owns 1000 shares in Company B currently worth S$1.00 each. C is interested in buying shares in Company B, but does not want to buy the shares yet.
A may sell C a share option to buy his 1000 shares one year from now at a price of $1.10 each. In return for this right, C pays A a sum of money, perhaps $0.10 per share, or $100.
One year from now, if the shares are worth more than $1.10, say $1.30, C can exercise his option, buy A’s shares for $1.10 each, and make an immediate paper profit of $0.20 per share.
If the value of the shares has instead fallen, perhaps to $0.80, then C may decide to forfeit his option. If a share option is not exercised before the due date, it becomes worthless.
Rather than pay $0.30 above market price for each share, he would logically decide that it is better to ‘waste’ the $100 he paid for the option.
Share options are therefore primarily a means to manage risk. If the share price rises, a would-be shareholder can ‘lock in’ a good price. If the price falls, an option-holder can restrict his loss to the option price. Either way, a current shareholder can generate some cash (the money paid for the warrant) while continuing to hold on to his shares and accrue dividends in the meantime.
What are Warrants?
Warrants are similar to share options. However, instead of being a contract between a shareholder and another party, they are entered into by the company itself and potential investors.
A company can issue share options to itself too, for example in relation to treasury shares. Further, rather than relating to pre-existing shares, a warrant is a contract which confers potential investors with the right to subscribe to new shares in the relevant company.
In the example above, C would instead pay $100 to Company B for the right to subscribe to 1000 new shares in Company B at $1.10 each next year.
Unlike share options which do not affect the capital of the company or shareholding proportions of the members of the company, the exercise of a warrant brings in fresh funds for the company but can dilute the holdings of pre-existing shareholders.
Advantages of Issuing Share Options and Warrants
Share options are primarily about risk management for shareholders and potential shareholders for shares traded on the open market. As shares in private companies have a fixed nominal value rather than an easy-to-calculate open market value, this is less relevant to the majority of SMEs.
However, private SMEs should consider issuing warrants. Selling warrants generates funds which can be used by the business without immediately giving rise to any real cost to the company. Warrants, unlike most shares, do not come with voting rights, avoiding or at least postponing issues of management control. Issuing warrants can be a way of creating a steady flow of investment if warrants of differing expiry dates are issued.
How Do I Issue Share Options and Warrants?
SME owners should also note section 240 of the Securities and Futures Act (SFA). The SFA stipulates that “offers of securities” (which includes share options and warrants) must be accompanied by a prospectus.
Prospectuses (and offer documents) are comprehensive documents commonly issued to investors in initial public offerings, and the preparation process is often lengthy and expensive. In order to avoid the prospectus requirement, issuers of securities usually rely on the private placement exemption under the SFA.
This exemption requires a series of conditions to be met, the most important of which is that the “offer of securities” must be made to no more than 50 persons within any period of 12 months. The SFA provides exemptions for some other offers of securities such as small offers where the total securities offered within any 12 month period are worth less than $5 million. In such cases, no advertising of the offer is allowed and those who buy such securities will often be restricted from reselling them for six months.
Employee Share Options
Crucially for SMEs, share options or warrants in the form of employee share options are a good way of incentive alignment which appropriately rewards key employees. If an employee is also a shareholder, that employee will theoretically be more dedicated to ensuring the long-run profitability of the company.
There are 3 main ways to issue employee share options:
- Employee Share Option Plan (ESOP): the employees are (partially) remunerated with the right to buy shares in the company at a favourable price. You may read more about employee share option plans in our other article.
- Employee Share Award Plan (ESAP): the employees are given shares outright.
- Phantom Share Option Plan (PSOP): the employee is simply paid a cash bonus which is directly linked to the share performance of the company. As opposed to giving a simple cash bonus, a PSOP can result in tax savings but specialist tax law advice should be sought.
Advantages and Disadvantages of Employee Share Options
For those issuing employee share options specifically, some other considerations apply.
Employee share options are most suited to the most senior and crucial employees. Awarding too many employee share options could result in excessive dilution of existing shareholders’ rights.
Further, companies may wish to consider creating a new class of shares to fulfil employee share options which do not attract voting rights and which have a clause preventing them from selling the shares within a certain number of years.
Additionally, ESOPs may be conditional on employee performance. For example, if an employee resigns before the option becomes due or fails to meet certain sales targets, they may be deemed to have forfeited their option. This results in better incentive alignment as employees know their remuneration is directly tied to the long-term performance of the company.
Removing voting or sale rights prevents any problem of employees’ shares being used by competitors to effect a hostile takeover. SMEs issuing ESOPs should note that companies are generally not allowed to subsidise the cost of buying shares in their own company.
Although there are certain exemptions to this rule for employee share options, the most straightforward way to do this is to sell the shares for nominal consideration. Buying even 100,000 shares at $0.01 each would amount to $1,000 in total, an affordable amount for a senior employee.
If your company wishes to issue share options or warrants, whether to employees or to investors, you will have to iron out the details of the different dividend, voting and other rights accruing to the potential shareholders. This will have to be properly reflected in the company constitution, and, preferably, in a shareholder agreement too.
Doing all of this can be a complex process, so it is advisable to consult a corporate lawyer.
You can also refer to our article on corporate lawyers to determine how a corporate lawyer can help your business.