[Q&A] Can Foreign-funded Enterprises Improve Employee Loyalty Through Equity Incentives?
2023. 2. 6
[Q&A] Can Foreign-funded Enterprises Improve Employee Loyalty Through Equity Incentives?
As a corporate law firm, we are used to answering many questions from our clients about their business in China. In this series of Q&A articles, we will discuss some of the topics that our clients have shown interest in.
Question: Can foreign-funded enterprises improve employee loyalty through equity incentives?
Answer: Talents play an important role in the core competitiveness of enterprises. Companies are confronted with increasingly fierce market competition in regards to retaining key talents and preventing poaching by rival companies. Traditional talent retention methods, such as performance pay and welfare benefits are not always enough.
In recent years, some Chinese companies, such as Huawei and CATL, have been managed to obtain many talents through providing equity incentives, talent development programs and non-compete restrictions. Having a high-quality pool of talents indisputably gives these companies an edge on the market.
When it comes to foreign companies, is it possible for them to apply the equity incentive to motivate their employees? The answer is YES. However, if the equity incentive program is not well-designed, companies may be facing some additional risks - with labor disputes and salary disputes that may evolve into equity disputes.
The implementation of equity incentive by foreign-funded enterprises also requires certain legal compliance measures, because they have to face additional hurdles compared to domestic enterprises (for example, related to foreign exchange management and regulatory control).
Below, we would like to briefly introduce some specific and feasible equity incentive programs and the relevant legal issues. For more information and specific measures, please feel free to contact us.
1. Direct allocation of equity to specific employees
Since the official implementation of the Foreign Investment Law in 2020, restrictions regarding the type of shareholders of foreign-invested enterprises have been lifted, which means that domestic employees may also obtain a certain percentage of the company’s equity, by way of investment or distribution.
The problem with this approach is that the enterprise does not want the transfer or inheritance of equity from their employees to other third parties; therefore, measures should be taken to develop a corresponding exit mechanism (e.g., restricted shares). If there is a high number of employees participating in the equity distribution (e.g., if all employees are involved), consideration can also be given to setting up a special purpose vehicle (SPV) to serve as a platform for the employee stock ownership plan.
2. Virtual shareholding
If a company is concerned about the potential risks of employees holding real shares, there is another method to consider – virtual shareholding, that is "assuming the company is a joint-stock company, calculating the value per share based on its net assets and transferring it to employees". With virtual shareholding, employees are entitled to enjoy the right to share dividends and share price appreciation, just like the nominal shareholders. This method requires a high level of asset accounting ability of the company, and the company needs to pay attention to the tax classification of the related employee compensation.
3. Equity options, share options
Equity option incentive is common in listed or pre-IPO companies. It refers to the company granting employees the right to buy a certain number of shares or equity in the company, at a pre-agreed price (often lower) when the conditions are met in the future. The equity incentive in this mode has higher requirements for the development speed and scale of the company; companies need to pay attention to the restrictive terms of the relevant options, reserved relevant equity, and share of share transfer.
4. Participation of domestic employees in the equity incentive plan of overseas listed companies
It is necessary to make the foreign exchange management declaration according to the regulations in China. In addition, particular attention should be paid to the possible inaccurate payment problems that may arise if the enterprise makes corresponding deductions for the wages of domestic employees. From the compliance point of view, it is recommended to re-enter into supplementary contracts with such employees.
