A well-structured Stock Option program retains talent. A poorly structured one creates unwanted partners.
A Stock Option program is an excellent tool that companies, including startups, can use to retain talent and stimulate employee performance in Brazil. The program allows employees to acquire shares in the company for a pre-established value after certain goals are achieved. To ensure the program does not become difficult to implement, and that the entry of new partners does not end up harming the company, it is essential that some precautions be taken, particularly when the plan is designed under Brazilian corporate law:
1. Criteria for Exercising the Option: It is essential that the program establishes objective criteria to allow the employee to acquire the share. A vesting period, the achievement of goals, or even the completion of a certain investment round can be used, for example.
2. Option Pool: Creating an Option Pool, a percentage of the share capital reserved to be used in the Stock Option offering, already establishing in advance the origin of the shares to be offered, avoids surprises, organizes the capital and helps ensure the smooth exercise of the Stock Option right. In Brazil, this is typically implemented through a capital increase authorized in advance by the company’s bylaws or articles of association, allowing new shares to be issued without requiring a fresh corporate approval each time an option is exercised.
3. Cap Table: The Cap Table must clearly reflect the distribution of shares among founders, investors and employees who join the Stock Option program. A poorly planned structure creates uncertainty about the company’s control and future profit distributions, which can discourage investors in the event of a sale. A well-structured Cap Table, on the other hand, shows that the company has control over its governance and is organized to receive new investment.
4. Business Management: It is important for the company to understand the influence the employee will or will not have over its management after joining as a partner. In Brazilian limited liability companies, the most common corporate form for startups in Brazil, the new partner will generally have voting rights on company decisions. In corporations it is possible to offer preferred shares, which grant priority in receiving dividends and in the event of liquidation but do not carry voting rights, or common shares, which do not have that priority but do carry voting rights and a share of profits.
5. Shareholders’ Agreement: Providing, within the Stock Option instrument itself, that the employee must join the company’s shareholders’ agreement upon exercising the right is another important safeguard for the company’s governance. This way, even as voting partners, new members will still be bound by the parameters already agreed upon among the existing partners, a mechanism Brazilian courts have consistently upheld and enforced.
6. Tax Treatment: How the program is structured has a direct impact on its legal nature and, consequently, on when and how taxation applies to the employee, whether treated as compensation, with labor and social security implications, or as a transaction of a commercial nature, taxed only upon the sale of the shares. This distinction has been the subject of considerable debate before Brazilian tax authorities and courts in recent years, which makes defining the right classification from the outset, rather than after a potential challenge, essential to prevent significant tax and labor liabilities down the road.
The construction of a Stock Option program in Brazil must be done in a personalized manner, attentive to the interests of each company, especially when there is also an interest in bringing investors into the business. More than an employee benefit, it is a governance decision: the impact of bringing in new partners should be assessed with the same seriousness given to any other strategic decision made by the company.
