Corporate law: ESOP in a start-up

What is an ESOP?

An ESOP (Employee Stock Option Plan) is a programme under which selected individuals who are key to the company are granted the right to acquire shares in the company in the future, after meeting certain conditions (usually related to the passage of time or the achievement of specific goals).

What role does an ESOP play in a start-up?

From a strategic perspective, an ESOP in a start-up fulfils two fundamental objectives.

Firstly, it is a tool for attracting and retaining key talent, especially when the company is unable to compete with mature market players in terms of cash remuneration. An employee stock option programme allows the economic interests of team members to be linked to the long-term growth of the company’s value. Secondly, an ESOP fosters a genuine sense of ownership. The beneficiary of the programme is not merely an executor of assigned tasks – they become a future participant in the company’s success. This mechanism strengthens motivation, increases responsibility for results and encourages decisions focused on long-term value growth (rather than short-term operational effects). From an investor’s perspective, a well-designed ESOP stabilises the team during financing rounds and reduces the risk of key people leaving before the planned exit. For VC funds, this is often one of the elements used to assess the maturity of a start-up’s corporate structure.

Contemporary ESOP programmes are not limited to full-time employees. They also cover B2B partners, board members, management and key advisors, i.e. all persons who have a significant impact on the development and valuation of the company.

When to go for an ESOP?

For start-ups, the rule is simple: the earlier an ESOP is planned, the more control the founders have over its structure.

The optimal time limit for implementing the programme is the first round of financing. After an investor (VC fund or business angel) comes on board, each issue of new shares leads to dilution, which in practice means that the investor will be interested in controlling the size of the option pool. This right often stems directly from the investment agreement (e.g. through a veto right on increasing the share capital).

In market practice, VC funds expect the so-called ESOP pool to be created before the investment (pre-money). This means that the dilution resulting from the creation of the option pool is borne by the founders, not the investor. Failure to plan the ESOP in advance can therefore lead to unfavourable negotiations when determining the company’s valuation.

Therefore, before starting investment talks, founders should: determine the target size of the pool (usually 5-15% of capital), decide whether the pool will be calculated as pre-money or post-money, include it in the cap table model (fully diluted shares structure), and design the basic assumptions for vesting and participation rules.

Types of option programmes

The structure of the programme is closely linked to the legal form of the company and its business strategy. There are three dominant models in trading:

• Classic options to acquire shares: In this model, the beneficiary receives a conditional right to acquire shares (in a limited liability company) or stocks (in a simple joint-stock company or joint-stock company) at a predetermined price (exercise price). Exercising the option leads to: an increase in the share capital, the beneficiary acquiring share rights, and entry into the ownership structure (cap table).
• Subscription warrants: A solution characteristic of joint-stock companies (S.A., and in certain structures also PSA). The mechanism consists of: adopting a resolution on a conditional increase in share capital, issuing subscription warrants, granting them to the beneficiaries of the programme, and enabling the acquisition of newly issued shares after the conditions have been met. Warrants give the exclusive right to acquire shares, excluding the pre-emptive rights of existing shareholders. This structure ensures a high level of legal certainty for programme participants – the beneficiary obtains a claim to acquire shares, and the issue itself is ‘reserved’ at the resolution stage.

This is the most structured model of a classic equity ESOP.

• Phantom Shares: A solution in which the beneficiary does not become a shareholder (does not enter the so-called cap table), but receives the right to receive a specific cash benefit, the amount of which is linked to the value of the shares (e.g. upon exit, sale of the company or IPO). Phantom shares do not dilute the ownership structure, but generate a financial obligation on the part of the company (or the company’s shareholders).

Key mechanisms and contractual clauses

The effectiveness and security of an ESOP programme depend on precise regulation of the rules in the regulations and programme participation agreements. The most important institutions include:

• Vesting period: The period after which the beneficiary may acquire the full pool of shares to which they are entitled in the company (e.g. 48 shares in 4 years). The market standard is a period of 4 or 5 years. Vesting can be linear (proportional over time) or progressive (e.g. back-end-loaded, when the number of rights acquired increases over time).
• Vesting Cliff: A grace period, usually lasting 1 year, which must elapse before the person covered by the programme can receive the first pool of shares. If the cooperation with the person covered by the programme ends before the expiry of this specified period, they do not acquire any rights related to the shares.
• Good Leaver / Bad Leaver: Clauses governing the consequences of leaving the company.
• Good Leaver (departure for reasons beyond the beneficiary’s control, e.g. random causes such as illness) usually means that the beneficiary retains the acquired rights.
• Bad Leaver (departure for reasons attributable to the employee, e.g. disciplinary dismissal, breach of non-competition clause) results in the loss of options on shares and often also in the compulsory resale of already acquired shares at their nominal value.
• Accelerated Vesting: A situation in which the vesting period is shortened and the acquisition of the pool of shares takes place more quickly (e.g. due to an exit).
• Lock-up: A temporary restriction on the transferability of shares, aimed at stabilising the shareholding structure, particularly important in IPO processes.
• Drag Along: An obligation on minority shareholders (ESOP beneficiaries) to sell their shares if the majority investor decides to sell the entire company (exit).

Challenges in the field of corporate law

However, the implementation of ESOPs in the Polish legal system faces significant limitations, depending on the form of business activity.

Limitations of limited liability companies (Sp. z o.o.)

A limited liability company is the most popular form of business in Poland, but at the same time the least flexible for a classic ESOP based on real equity. The main limitations include:

• the lack of subscription warrants and conditional capital increases in a structure analogous to that of a joint-stock company (S.A.),
• the requirement to maintain the form of a notarial deed when selling shares,
• the problem of so-called ‘small numbers’ – the minimum nominal value of a share is PLN 50, which makes it difficult to precisely shape the option pool and percentage proportions.

Flexibility of a Simple Joint-Stock Company (P.S.A.)

The Simple Joint Stock Company was designed with a flexible ownership structure for start-ups in mind. The key advantage of a P.S.A. is the structure of shares without nominal value, which eliminates the problem of ‘small numbers’ and allows for the free shaping of the option pool (even with low share capital). Furthermore, trading in P.S.A. shares only requires a documentary form under pain of nullity, which makes it possible to conclude share subscription agreements in electronic form, without the need to involve a notary public each time an employee joins the company.

Capital instruments in a joint-stock company (S.A.)

A joint-stock company, which is the target form for entities planning an initial public offering (IPO), has the most advanced legal mechanisms for handling ESOPs. The Commercial Companies Code provides for a conditional increase in share capital and the issue of subscription warrants – instruments giving the holder the right to subscribe for new shares. This legal structure guarantees beneficiaries a high level of legal security (claim for the issue of shares) and provides the management board with corporate stability.

Tax law challenges

In the case of a limited liability company, there are no explicit preferences in tax regulations that would automatically defer the generation of income until the shares are sold for consideration (as is the case with joint-stock companies and public limited companies). As a result, there is a significant risk of interpretation as to when income is generated on the part of the person covered by the ESOP.

Tax authorities have interpreted that acquiring shares at a price lower than their market value may be considered a financial gain arising at the time of acquisition. Consequently, the difference between the market value and the acquisition price may be classified as income: from employment (if the beneficiary is an employee), from personal activity (e.g. a member of the management board or a B2B associate) or from other sources, depending on the beneficiary’s legal relationship with the company.

This structure may lead to a situation where the beneficiary has to pay tax ‘out of their own pocket’ before actually obtaining any profit from the sale of these shares — which in practice is called ‘paper profit’ taxation.

However, it is worth emphasising that this is not an absolute rule, and there are individual interpretations and rulings which assume that the mere acquisition of shares in a limited liability company does not necessarily lead to immediate income. Nevertheless, the lack of a preferential statutory norm in the case of a limited liability company means a real tax risk that must be carefully managed when designing the programme.

The situation is different in the case of a joint-stock company and a simple joint-stock company. The provisions of the Income Tax Act (in particular Article 24 paragraph 11-12a of the Income Tax Act) provide for the possibility of deferring the moment of revenue generation until the sale of shares, if the incentive programme has been introduced on the appropriate terms (i.e. on the basis of a resolution of the relevant company body, as part of an incentive programme within the meaning of tax regulations, and subject to the fulfilment of other statutory conditions).

In such a case: the acquisition of shares does not generate taxable income on the part of the beneficiary, the moment of recognising the income occurs only when the beneficiary sells the shares for consideration, the income from the sale of shares for consideration is taxed as capital gains – usually at a rate of 19%.

This solution gives beneficiaries tax neutrality until the actual sale of the shares, and not just their acquisition.

Summary

The implementation of an ESOP programme is a multidimensional process combining elements of corporate law, labour law and tax law. Choosing the right model and drafting a precise agreement are crucial for securing the company’s interests and avoiding conflicts at the stage of investor entry or sale of the company, but it is also crucial for the employee to be properly rewarded for their contribution to the company. A professional legal analysis allows the structure of the programme to be tailored to the stage of development of the organisation and the specifics of the Polish legal system.