1. How do I avoid a prospectus or other disclosure document?
For an unlisted company the largest consideration at the outset is the disclosure filing requirements. If rights/options or shares are issued, any offer will be subject to the disclosure filing requirements (prospectus, short form prospectus and offer information statement) under Chapter 6D of the Corporations Act 2001, specifically section 706.
There are a number of exemptions that can be relied upon to exempt a company from these disclosure filing requirements. There is some cost and complexity in producing a disclosure document so it is important that a company consider the below and ensure that it can rely on one or a number of exemptions.
The common exemptions used are:
Exemption 1 – Section 708(1) allows a company to make offers to 20 individuals in any twelve month period up to a certain dollar cap ($2,000,000).
Exemption 2 – Section 708(12) exempts offers that are made to senior managers. The definition of ‘senior manager’ for the purpose of this section is a person:
(a) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or
(b) has the capacity to affect significantly the corporation’s financial standing.
An individual falls into the exemption if either (a) or (b) are met.
Both the exemptions are automatic so nothing else needs to be done before an offer is made, if you fall into the above categories. These exemptions will exempt a company from prospectus filing requirements, anti-hawking provisions and also AFSL and FSR requirements.
There is a prospectus filing requirements within the Australian Securities and Investment Commission (ASIC) Class Order for employee share and option plans CO 03/184. However the only exemption for unlisted companies is for options, with the requirement that a prospectus is lodged prior to any exercise, for most companies this has very limited use.
If a company uses units in a unit trust the prospectus filing requirements do not usually apply but FSR requirements will apply, like e.g. the requirement for a PDS.
2. Should I change the share structure?
Commonly companies may have a small number of shares in the hands of a few individuals with a high dollar value per share. This structure is usually changed when an employee share plan is introduced. An employee is less likely to understand the value of the share and will be less incentivised by owning e.g 10 shares with a high value rather than 1,000 shares with a lower value. This restructure can also create a pool of issued shares that can be used for the plan and this may overcome the prospectus filing requirements?
3. How do I value the shares?
Unlisted companies do not have access to a market, and therefore, must rely on values determined by an approved valuation method. Generally a company would value their shares on an annual/biannual basis using an agreed formula and provide this information to their employees, so they know how their investment is going.
4. How do employees sell there shares?
Most shares in listed companies can be freely traded on the stock market. There is usually no ready market for shares in unlisted companies. Therefore, in order to provide liquidity for ESOP participants an appropriate mechanism for buying and selling shares needs to be created. This is usually only provided after the employee has been in the plan for a certain period and there are usually provisions about who the shares can be sold to, i.e. employees in the plan, the company or other employees. There is usually an order of preference and disposal windows usually tie in with the valuation periods.
5. How do I minimize minority shareholder issues?
The proprietors of many private companies need to have full control of their company to satisfy borrowing covenants, trade sale or IPO requirements. Commonly companies have the plan run by a trustee that enters into a ‘Shareholders Agreement’ with the company and this can exclude voting rights for example and will include drag along and tag along provisions to ensure there are no minority shareholder issues at the point of sale/exit for the owners.
6. Do I need a Trust?
A trust is often used to hold shares on behalf of employee participants in ESOPs. Trusts are used for a variety of reasons, including:
- To administer the various performance and/or vesting conditions that can apply to an ESOP. This allows shares to be held and then reallocated to other employees if the performance conditions are not met.
- To enable the orderly and cost effective acquisition and disposal of small share holdings, e.g. when an employee leaves or wants to sell. This is particularly important for small thinly traded stocks and/or for foreign resident employee participants.
- To avoid multiple small shareholders on the register which avoids multiple signatories and complexity.
- To enable a company to control and manage its exit plan.
- To create restrictions on the shares. The trust can be used to restrict voting, i.e. there is no voting or it is at the direction of the trustee.
A trustee of an ESOP trust may require an Australian Financial Services License (AFSL), although most companies will be exempt from this if they are relying on the prospectus filing exemptions set out above.
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