Focus on STIB regulations on equity incentives

By Wang Yan, Grandway Law Offices

The drafting of a legislative framework for the Science and Technology Innovation Board (STIB) comprising main rules and review procedures, which began in January this year, was completed quickly and attracted a great deal of attention from various circles.

For companies intending to go public on the STIB, and that would benefit from strong technology innovation capacity, equity incentive plans with operationality and flexibility may be significantly helpful for consolidating existing technological advantages and attracting more core talent.

Extending the scope of application of the Guidelines for the Implementation of Employee Stock Ownership Plans and Option Incentives by Pilot Innovative Enterprises from pilot innovative enterprises to include STIB issuers, the recently drafted STIB regulations also bring breakthroughs in respect of criteria. Below is a summary of the key takeaways that deserve attention.

王岩 -Wang Yan-国枫律师事务所-合伙人-Partner-Grandway Law Offices
Wang Yan
Grandway Law Offices

First, during the review procedure, a more tolerant approach is taken to equity incentive plans existing prior to IPO filing. In contrast to the review procedure for A-share IPOs, which takes a prudent approach to equity incentive plans not completely implemented as of filing (usually these plans are required to be terminated or restored), the Q&A Summary of Shanghai Stock Exchange Concerning Review of Stock Offerings and Listings on the STIB explicitly states that the STIB will recognize all equity incentive plans established by potential issuers prior to IPO filing and to be implemented both before and after their IPOs, provided that the specified review and disclosure principles are met.

Second, the permitted vehicles for holding STIB issuers’ employee stock ownership plans (ESOPs) established and implemented prior to IPOs are further diversified. In the above-mentioned Q&A summary, regulators clarify that the scope of permitted holding vehicles is expanded, from companies and partnerships as previously authorized, to include asset management plans. This change provides more possibilities for optimizing shareholding costs and structures.

Third, ESOPs meeting the “closed-loop principle” are allowed to have more than 200 beneficial owners; moreover, their holding vehicles are exempt from filing procedures applicable to fund products. These regulations provide a compliance basis for highly developed STIB issuers to implement equity incentives with wide coverage.

The provision that allows exemption from filing also helps STIB issuers implementing equity incentives of this kind to effectively avoid circumstances where some potential incentive receivers have to be “rejected” because they are not qualified as investors of private equity funds.

Fourth, the new regulations expand the scope of permitted incentive receivers under option plans, and raise the percentage that option plans are allowed to account for in total capital. According to the Measures for Ongoing Regulation over Issuers on the Science and Technology Innovation Board (Trial), the Rules of Shanghai Stock Exchange for Listing of Shares on the Science and Technology Innovation Board, and the Q&A summary, the scope of permitted incentive receivers under option plans of STIB issuers is further expanded to include “shareholders who either alone or jointly hold 5% or more equity in listed companies, or actual controllers of listed companies, or their respective spouses, parents and children, and directors, officers, core technicians and business staff members of listed companies”.

It also raises the total percentage that effective option plans are allowed to account for in the total capital, from 10% prescribed in the Measures for the Administration of Equity Incentives of Listed Companies, to 15% before listing, and 20% after listing.

In view of the above regulations and needs of STIB issuers in practice, the author has three recommendations in respect of equity incentives of STIB issuers.

First, in line with its development needs before and after the IPO, an STIB issuer may establish an option plan with a term commencing before and ending after the IPO review process, provided that the plan meets the requirements of the Measures for the Administration of Equity Incentives of Listed Companies.

However, according to the Q&A summary: (1) during the review process, the STIB issuer shall not create any new option plan for incentive purposes, nor are relevant incentive receivers allowed to exercise their options; (2) incentive receivers shall undertake that, for three years since the exercise date, they will not sell off any shares acquired through exercise of options after IPO of the issuer, and they shall also agree that provisions restricting selling of shares by directors, supervisors and officers shall apply mutatis mutandis to them upon the expiration of the said lock-up period.

Second, STIB issuers should determine the pricing principles and implementation timetable of their option plans and ESOPs reasonably. According to the Q&A summary, the exercise price of options shall be determined by holders through consultation, but in principle should not be lower than the audited net asset or valuation value of the latest year. In principle, the prices for acquiring incentive shares under ESOPs should not be lower than the said values, although the Q&A summary does not set restrictions in this regard.

As far as implementation is concerned, it is advisable that STIB issuers develop and implement incentive plans as early as possible and determine prices of incentive shares reasonably, taking into account factors such as the effects and financial costs of their incentives. In this way, they may avoid circumstances where recognition of administrative costs based on the difference between fair value and share purchase cost of incentive receivers – arising due to rapidly increasing valuation, which is not uncommon among STIB issuers – causes impact on their financial data. Attention should also be paid to tax implications if incentive shares are granted by the controlling shareholder by way of transfer.

Third, given that innovative enterprises rely heavily on their core team members for research and development, to restrict an exercise of rights or exit by core team members, defined quantitative standards may be set as preconditions for acquiring incentive shares. These may include specific financial key performance indicators or specified milestone events.

Clear and feasible repurchase and dispute settlement approaches for dealing with failure to meet conditions for exercise of rights or any material breaches arising after granting of incentive shares should also be specified, so that no subsequent disputes will cause any adverse impact on the IPO plan or on the overall effectiveness of future incentive granting.

Wang Yan is a partner at Grandway Law Offices


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