1、 Generation and implementation purpose of equity incentive (employee stock ownership plan)

Employee Stock Ownership Plan (ESOP) is a form of corporate property rights that emerged in the 1950s in the United States and has been widely implemented in the past 20 years. It belongs to a special compensation plan, which refers to a benefit sharing mechanism and a participation mechanism that allows employees to enjoy residual claims through holding stocks in order to attract, retain, and motivate company employees. An employee stock ownership plan is essentially a benefit plan that is applicable to all employees of the company. The company allocates shares of the company based on factors such as salary grade or working years.

In practice, ESOP is widely used in a variety of corporate restructuring activities, including replacing or assisting the purchase of private companies, divestitures, rescuing companies on the brink of bankruptcy, and anti takeover defense. Some companies use ESOP as a means of corporate financing. From the perspective of business owners, the main uses of ESOP can be summarized as follows: 1. Implement capital accumulation as a means of corporate financing; 2. Providing an internal trading market for the stocks of non-public holding companies; 3. An alternative to listing; 4. Preventing malicious acquisitions; 5. The company smoothly abandons and transfers subsidiaries with unsatisfactory operation; 6. Realize the transfer of company ownership to employees; 7. Provide incentive mechanisms to motivate employees and promote production improvement; 8. Provide security for employees' retirement.

2、 Discrepancies in the Judicial Practice of Equity Incentive Disputes

In practice, there are often certain restrictions on the conditions for the exercise of equity incentives or the transfer of incentive shares. There are three common conditions for exercising rights: (1) the formation of a labor relationship between employees and the enterprise has reached a certain period of time; (2) The employee's job performance or performance meets the evaluation standards or makes outstanding contributions to the enterprise; (3) Employees have signed a non competition agreement with the enterprise and are obligated to compete. There are three main restrictions on the transfer of incentive shares held by incentive objects due to withdrawal: (1) being purchased or transferred by the enterprise to designated personnel; (2) The transfer price is adjusted by the labor term or performance evaluation; (3) 

The transfer price is also affected by the restriction period and whether the incentive object has faults. In the process of enterprises deciding to implement employee stock ownership plans, the above exercise conditions and exit restrictions often combine, largely becoming the main reason for judicial disputes.

In judicial practice, disputes arising from equity incentives mainly revolve around the civil code contract, company law, and labor law. Currently, there are differences as to whether equity incentive disputes should fall within the scope of labor disputes. The holder of the affirmative view believes that the labor contract relationship is the basic legal relationship of equity incentive, and the generation of incentive relationship is actually based on the labor contract relationship; The vesting conditions are based on the existence of labor relations, and incentive plans should actually be considered as part of the company's compensation plan. On the contrary, those who hold a negative view believe that stock options should not belong to the traditional labor law meaning of wages, performance, bonuses, and other remuneration that employees can obtain according to labor relations; An incentive contract is generally signed between an enterprise and employees, and the two parties should have a contractual relationship.
Based on the above theoretical differences, in cases of judicial practice, regarding the signing of incentive contracts between employees and enterprises regarding the grant of options, the court has determined that disputes arising from the grant of options are contractual disputes. However, there are still a large number of judgments that directly reject the parties' lawsuits based on the "labor dispute cases, which should be subject to the labor arbitration pre procedure". When the parties apply for labor arbitration, the labor dispute arbitration institution will reject the application based on the "not falling within the scope of labor dispute", resulting in an embarrassing situation for the parties.

3、 The significance of building an employee stock ownership platform

It is a common practice in practice for companies to establish a shareholding platform as a means of motivating employees. That is, companies establish limited liability companies or limited partnerships as shareholding platforms, where employees sign option incentive agreements, partnership agreements (capital contribution agreements), etc. with the shareholding platform, and receive company shares by becoming shareholders or partners of the shareholding platform. In fact, this incentive method can largely avoid the conflict between equity incentive disputes and labor disputes, resulting in a situation where there is no way to solve. In addition, the greater significance of building a shareholding platform lies in:

(1) Helps to solve the problem of a large number of incentive objects

In practice, there may not be a few employees who meet the conditions for exercising their rights, but China's company law imposes restrictions on the number of shareholders in a company. However, as the company gradually develops and expands, if the company directly holds shares, the incentive target often exceeds the limit. In this case, the company establishes multiple shareholding platforms, allowing employees to participate in the incentive plan through indirect shareholding. Currently, for multiple shareholding platforms, except for the private equity fund industry, there are provisions for penetrating the cumulative calculation of investors. Currently, national laws have no policy restrictions on shareholding platforms in the field of equity incentive, and no penetration verification will be conducted.

(2) Conducive to the control of the target company

In the adopted shareholding platform construction method, limited partnerships are used as the shareholding platform. Due to the particularity of limited partnerships, that is, LP (limited partners) only contribute funds and do not participate in the operation and decision-making of the partnership, which can greatly protect the actual control of the company's founders over the company. By being responsible for managing and exercising all voting rights on the shareholding platform as a GP (General Partner), the founders can firmly control the target company in their own hands.

(3) Facilitate efficient decision-making and management for the company

If a company needs to conduct large-scale equity incentives to motivate more than ten or even dozens of employees who meet the exercise conditions, and if these employees directly hold company shares as shareholders, it will first affect the effectiveness of decision-making. The company law stipulates that all shareholders should be notified before convening a shareholders' meeting, and regardless of the voting rights ratio of these employees, the pre meeting process will be very cumbersome, "If a shareholder is not notified, the resolution formed at the shareholders' meeting is a resolution with defective effectiveness.". Secondly, indirect shareholding through a shareholding platform is also convenient for the management of the target company, especially when motivated employees withdraw due to disputes, often only relevant issues need to be resolved at the level of the limited partnership, without involving the target company, avoiding frequent changes in the shareholders of the target company, and also ensuring the stability of the target company's equity structure for management.

(4) Favorable financing

In the stage of corporate financing, investors generally prefer companies that have reserved option pools when selecting target companies, because when option pools have been reserved, investors will not dilute their equity due to incentives and attracting talent after investment. The model of reserving option pools is more conducive to the introduction of investment by target companies.

(5) Facilitate differentiation and resolution of disputes

We also mentioned above that when motivated employees exit, if disputes arise, they only need to resolve relevant issues at the limited partnership level, without involving the target company. This makes it easier to distinguish between types of disputes, avoid adjudicative differences, and effectively resolve disputes.

4、 Matters needing attention during the construction of employee stock ownership platform

When a limited partnership serves as a shareholding platform, the general partner is usually assumed by the founder of the target company, and the general partner assumes unlimited joint and several liability for the debts of the enterprise. In this case, if the partnership is only a shareholding platform and does not conduct any external business, there will be no risk for the general partner. If external participation in investment and operation is required, there will be certain risks in investment decision-making and actual operation. You can register a limited liability company to serve as the GP of the limited partnership, reasonably avoiding the risk of assuming unlimited joint and several liability.

The exit mechanism of the shareholding platform is particularly important in the entire incentive plan. The employee shareholding platform must have shareholders and partners in and out. When setting up the exit mechanism, as the original employees of the platform, their share repurchase mechanism needs to be designed reasonably, which can be held by major shareholders and then transferred to new incentive targets. When establishing the articles of association and drafting agreements, It should also be specially agreed that the original employees should give up the preemptive right to purchase this part of the equity shares.

In a growing startup, the founder must have control. It is generally recommended that voting rights be concentrated in the hands of the founder. The legal representative is generally the founder, and the voting rights of employees as shareholders should also be entrusted to the founder.

Regarding the registration location of the shareholding platform, it is generally preferred to register as a partnership enterprise in a low tax bearing region with tax incentives or financial returns. For employees, there are tax incentives when exiting the shareholding platform for equity transfer, which is also a safeguard for employees.
"Regarding the share transfer price of the shareholding platform, there must be an agreement in the incentive agreement. If the lockup period expires after the employee exercises his/her rights, the company should give the employee a notice of withdrawal. One is for the GP to purchase at a market price, and the other is for the GP to sell in the market to provide sufficient protection for the employee. The establishment of the shareholding platform is only meaningful. Of course, this situation should be based on the employee's faultless promotion.".

6. Regarding whether the incentive stock rights can be divided, it is also recommended to stipulate in advance in the incentive agreement. Regardless of whether it is within the equity restriction period, the incentive stock rights cannot be regarded as the joint property of the husband and wife, and the spouse of the incentive employee cannot claim shareholder status. Instead, the incentive employee should provide property distribution compensation or other means of negotiation for the spouse. To prevent the occurrence of extreme situations.

7. It is also important to note that when a company is preparing to establish a shareholding platform, it must raise funds from specific targets within the company, such as employees. When establishing a shareholding platform, the company should also guard against the risk of illegal fund-raising. It is not possible for anyone willing to buy shares in the company to recruit them into the company. If it is to make contributions to an unspecified target to purchase your shares, once the number of eligible individuals is large, If the amount is large, it is a risk for the enterprise.