What a buyer sees in your employee participation plan

Most founders set up employee participation to keep good people. Years later the same plan shows up in a data room, and it is read by someone whose job is to find reasons to pay less. That is a very different reader than the employee it was written for.

Motivation

Why buyers look at it early

A participation plan touches three things a buyer cares about at once: how much of the value is already promised away, whether key people stay after closing, and whether there is an unpaid liability hiding in the past. That is why it usually appears in the first document request, next to the cap table and the employment contracts.

A buyer does not object to participants earning money at exit. That is the point of the plan and it is priced in. What a buyer objects to is not being able to calculate it.

Data room

The documents they ask for

• The plan rules. One document, current version, with the amendment history.
• Signed grant agreements per participant. Signed, not drafted.
• A register of who holds what. Grants, vested and unvested, reference value per grant.
• The valuation substantiation. Which method, which date, who produced it.
• The leaver history. Who left, on which basis, what happened to their entitlement.
• Board or shareholder approvals. Whatever your articles require for the plan and each grant.

If that set is complete and internally consistent, the plan is usually off the critical path in days. If it is spread over a spreadsheet, an inbox and someone's memory, it becomes a workstream.

Pricing

Overhang and the price

Overhang is the share of company value already committed to participants. A buyer wants four answers: what is the percentage, is it capped, does it dilute the buyer after closing, and who pays it out. In a cash settled SAR or virtual share plan the payout typically comes out of the proceeds at exit, so the arithmetic is straightforward: the participants' part is deducted, the sellers receive the rest.

Where it gets messy is a plan without a defined ceiling, or one where the payout formula can be read two ways. Two readings of the same clause is exactly the kind of thing that ends up in an escrow.

History

Leavers and open promises

The most common finding is not in the current plan, it is in the past. Someone who left three years ago and was told "we will sort it out at exit". A grant discussed in a review meeting and never documented. A departure where nobody recorded whether it was a good leaver or a bad leaver.

Each of those is a potential claim, and a buyer will either want it settled before closing or covered by the sellers. Clear vesting and leaver rules that were actually applied at the moment someone left prevent almost all of this.

Tax

Tax and payroll exposure

A buyer inherits the payroll history. So the question is whether wage tax was handled correctly at the right moment, and whether the plan's tax treatment matches how it was actually run. A plan documented as cash settled but paid out in shares once, as a favour, is a red flag.

Cash settled plans are the simpler case: the payout is wage, it runs through payroll, and it is generally a deductible expense for the company. Real shares, depositary receipts and options bring their own history that has to be reconstructed. See also how the Dutch tax boxes apply to each form.

Closing

What happens at closing

Your plan should already answer this. Does unvested value accelerate at a change of control, or does it continue under the new owner? Is the payout in cash at closing, or does part of it follow an earn out? What happens with participants who stay on and were counting on the plan as their reason to stay?

A buyer often wants retention, not a full payout. A plan that can do both, settle what is vested and roll the rest forward, is worth more than one that forces a single outcome.

There is a practical difference here between plan types. A cash settled plan needs no notary and no new shareholders at closing. With real shares or depositary receipts, every holder is a party to the transaction, and every party is a signature you have to collect under time pressure.

When the exit is lower than hoped

Investors often hold a liquidation preference: at a sale they get their investment back first, sometimes with a multiple, before the rest is shared. At a modest exit price that leaves less for everyone else, participants included. Check how your plan defines the value a payout is based on: the headline price, or what is left for ordinary shareholders after preferences and transaction costs. Model a low scenario as well as a high one, so nobody is surprised at closing.

Checklist

Checklist before you start a process

• Every grant is signed and stored in one place, with the reference value per grant.
• The register reconciles with the plan rules and with payroll, to the unit.
• Every departure has a recorded leaver classification and outcome.
• The payout formula produces one answer, and you can demonstrate it with an example.
• The change of control clause says what happens to vested and unvested value.
• Valuations follow one method, applied on fixed dates, with the substantiation kept.
• There are no promises outside the documents. If there are, settle or document them now.

Sharesquare provides software and educational content, not tax or legal advice. Have your own transaction reviewed by a qualified adviser.

Knowledge base

Frequently asked questions