The binding together of the long-term interests of enterprises in such new economy industries as high-tech, the internet, etc., with those of their core employees is an indispensable requirement for a company’s development and growth. Fortunately, the Science and Technology Innovation Board (STIB) has gone beyond the current regulations for A shares, giving the pre-listing employee equity incentive plans of enterprises new room for realizing their effect.
The main relevant rules include the Rules of the Shanghai Stock Exchange for the Listing of Stocks on the Science and Technology Innovation Board (listing rules), the Answers of the Shanghai Stock Exchange to Questions on the Reviews for the Offering and Listing of Stocks on the Science and Technology Innovation Board (review questions) and the Administrative Measures for the Equity Incentives of Listed Companies (measures).
CORE ELEMENTS AND BREAKTHROUGHS
Incentive share pool. Company shares may serve as the subject matter of an innovative tech enterprise’s incentive shares, and may take the form of restricted shares, stock options or other forms recognized by the stock exchange. The total number of valid stocks encompassed in the option incentive plan of an issuer may not exceed 15% of its total pre-listing share capital and may not be encumbered by reserve rights. The author believes that this is a breakthrough on the current “issuer’s equity is clear” requirement for A-share IPOs. Past A-share IPOs did not permit uncertainty or material changes in the equity structure of the issuer during the review period, or in the existing shares during the post-IPO lockup period.
Form of shareholding. The employee shareholding plan of an innovative tech enterprise may indirectly hold shares through a company, partnership, asset management plan, etc.
The STIB goes beyond the existing review criteria for A shares, permitting an employee shareholding plan to serve as a shareholder of the issuer. A brief comparison is provided below.
- Governance structure. A limited company may have one to 50 shareholders and a stock company two to 200 shareholders. The internal decision-making body is the shareholders’ meeting, board of directors or executive director; and the main basis for its operations is its articles of association. A partnership may have two to 50 individual limited partners. The internal decision-making body is the partners’ meeting, GP; and the main basis for its operations is its partnership agreement. An asset management plan is limited to 200 persons. The internal decision-making body is the employee shareholding plan holders’ general meeting, management committee; and the main basis for its operations is its management measures.
- Tax costs. Where a limited company serves as the shareholder platform, enterprise income tax is levied and individual income tax on the incentive recipients. A limited partnership shareholding platform only requires each of the partners to file their taxes, usually at the rate of 20% of the investment returns, some regions applying a 3-5% progressive tax system. Asset management plans are first subject to value added tax at the rate of 3% (actually shared by all of the holders), individual income tax on natural persons is governed by different tax provisions that vary depending on the type of income such as dividend income, share transfer income, equity transfer by the platform, etc., and the holders additionally share other operating costs such as the manager’s management fee, the custody fee, etc.
Scope of incentive. (1) The listed company’s directors, senior officers, core technical personnel; or core business personnel and other employees that the company deems necessary to incentivize and who have a direct impact on the company’s business performance and future development, excluding independent directors and supervisors; (2) shareholders who alone or together hold at least 5% of the listed company’s shares, the listed company’s actual controller and their spouses, parents and children, and employees with foreign nationality who satisfy the service requirements in (1) above may also be incentive recipients; and (3) the prohibiting circumstances set out in the measures may not apply thereto.
The author understands that (2) above represents a breakthrough on the scope of the incentive recipients – so long as such persons satisfy the requirements for their positions, and necessity and reasonableness is explained, they may be included within the scope of incentive recipients.
Penetrative calculation principle. The review questions state that if an employee shareholding plan complies with the “closed loop principle” in its operations, or if it does not operate based on the “closed loop principle” but has carried out recordal with the Asset Management Association of China, it is counted as a single shareholder when counting the number of the company’s shareholders. If not, when counting the number of shareholders, the number of beneficial holders will be counted in a penetrative manner. However, an employee stock ownership plan (ESOP) organized in the form of an asset management plan must carry out recordal with the Asset Management Association of China, which has nothing to do with whether the closed loop principle is complied with or not.
Capital contribution in form of scientific and technological achievements. An employee may make his capital contribution in the form of scientific or technological achievement to obtain an equity stake. The company has to conduct a lawful valuation, timely carry out procedures for property rights transfer and deliver the same into the company’s possession. At such time, the company will enter the same in its accounts at its appraised value, and when the incentive shares are transferred in future, the appraised value will serve as the original value for determining the individual income tax base.
In the past, when an A-share listed enterprise implemented an equity incentive before its listing, the source of the funds of the incentive recipients was limited to the employee’s own funds, remuneration, or actual controller loan.
Payment in form of shares. The granting by an enterprise of equity instruments, or the transaction carried out by an enterprise that determines a debt based on equity instruments in order to secure the services of employees, constitutes a payment in the form of shares. The expenses relating to a payment made in the form of shares are reflected in the management expenses, and an increase in management expenses will affect the profit reflected in the statements.
Currently, the listing rules set a hard requirement for net profit only for applying enterprises that have a market value of between RMB1 billion (US$145 million) and RMB1.5 billion. Net profit does not serve as a substantive condition for applying enterprises of other sizes.
Where the implementation of an equity incentive constitutes a payment in the form of shares, the review rules only require the issuer to fully disclose the same and to ensure that the fair value computation is reasonable, and that the accounting treatment is compliant. The author believes that the system openly encourages enterprises to implement employee equity incentives before they list so as to bind together the long-term interests of the company and its employees, which can in turn ensure the enterprise’s continuing operating capabilities.