The Impact of ESOP incentives on CEE's corporate culture

Marija Tešić: 
Thank you, Sašo. Hi to all. Well, an employee stock ownership plan, or ESOP for short, is a programme that enables the employees to become minority shareholders or partial owners of the shares in a company. It happens by granting them the shares or the option to buy shares or receive shares at some later stage. Usually, this is at some moment when the company reaches certain key milestones. There are various models, but in any case, it is now becoming an attractive incentive for CEE companies in this region also. It used to be a widely used model in other regions, especially in the Western countries and in the USA, where it originated. The basic rationale was that it makes for a more committed and engaged workforce. They [ESOPs] increase the motivation of the employees by connecting them more with the company. When we talk about our region, all countries introduced them in their own time with their own specifics. For example, in Serbia, they were not officially introduced until 2021 in the amendments to the Companies Law, and there are countries in which they are still not officially recognized, or they are recognized only for certain types of companies. In Serbia, we can use them only for limited liability companies. However, multinational companies, even before, applied these programmes for some years already in respect of all employees or contractors [in countries] where they have subsidiaries, even in those where ESOPs are not officially recognized. How did that work? Well, because the employees are not always granted shares in the actual company they work for, but in some other company within the group. So in the case of Serbia, even before ESOPs were officially introduced, we were often approached by our clients to support and advise them with respect to the granting of shares to employees located in Serbia.

Sašo Papp: 
Thank you. Teodora, Scalefocus has implemented an ESOP programme. Could you share what motivated your company to introduce an ESOP?

Teodora Bobcheva: 
First, hi all, and thank you for having me here. What I can share is that our company introduced an employee stock ownership plan as a strategic move because the shareholders wanted to align the interests of our employees with the long-term success of the company. And basically, we at Scalefocus always aim to foster a stronger sense of ownership, loyalty, and commitment among our colleagues. And one way to achieve that is by offering phantom shares and stock options to key employees. Phantom shares and stock options are the two plans that we introduced in the company. An ESOP incentivizes employees to perform at their best, and also, such programmes create a culture of shared success, where everyone benefits from the company's growth and profitability. And I completely share the opinion of Marija, because while ESOPs are common for US companies, they were not popular in Bulgaria initially. And as we all know, foreign companies with offices here in Bulgaria already have ESOPs in place, and they provide them for their employees, while local companies still, I think, see it as some kind of a novelty. Therefore, our company started offering our employees similar benefits, and in this way, the company is relevant and competitive and, of course, retains and attracts top talent. 

Sašo Papp:
Oh, nice. Looking at the topic from your perspective, Marija, what are some essential legal considerations for companies thinking about implementing an ESOP in the CEE region?

Marija Tešić:
Well, I think it's crucial to be aware of these diverse legal and regulatory regimes across the different countries in the CEE region. As I said already, ESOPs are often cross-border and include employees in several jurisdictions where one group of companies operates. So it is important to work with legal experts who understand the specific requirements in all these countries. So, in the country where the actual company of which the shares are granted is located, as well as in those where the employees are located. Such requirements include tax implications, reporting obligations, fair valuation methods, and foreign exchange concerns. Then, also, it is important to check the local capital markets regimes to ensure that the ESOP does not trigger the local capital markets regimes, and if it triggers them, to cover it properly. So there are various aspects.

Sašo Papp:
Marija, you mentioned tax implications. Could you share maybe some insights into the tax implications for employees participating in an ESOP programme in the CEE region?

Marija Tešić:
Well, yes. Taxation of ESOPs, like everything else, also varies across CEE countries. In some countries, employees may face taxes at the time they receive the shares, while in others only when they further sell them off. The tax rates and treatment of capital gains are also different, but ESOPs can usually be beneficial for both the company and the employees. So it is crucial for employees to understand all legal, financial, and tax implications of participating in ESOPs, so they can plan and make informed decisions accordingly. As always, transparent communication is key to successful ESOPs and to satisfied and motivated employees.

Sašo Papp:
So basically, it's very important because there are some specifications, specific country regulations, right?

Marija Tešić:
Yes, yes.

Sašo Papp:
OK. Teodora, in practice, were there any specific challenges or hurdles your company faced during the implementation of the ESOP programme? Also, what do you recognize as major benefits for companies implementing ESOPs in the CEE region?

Teodora Bobcheva: 
Sure, definitely, implementing an ESOP programme certainly comes with its challenges. And this is especially valid for the CEE region, where regulatory frameworks might differ. And not only this, but our local legislation is significantly different from that in the US, where ESOPs are a lot more popular. And one of the major hurdles we faced was adapting the concept of employee stock ownership plans to fit our regional context, where the US model and technology were not widely understood. And as you can imagine, this required extensive efforts to educate our employees about the local concept and why we took the specific approach. What I can additionally share is that designing a plan that addresses key employees at different levels, drafting documents that best reflect the plan, navigating tax implications, and financial reporting requirements posed significant challenges, and that is exactly where our team creativity had to shine. But I can share that all these challenges were outweighed by the benefits of implementing ESOPs, because ESOPs enhance employee retention and attract top talent. And moreover, ESOPs can be a powerful tool for succession planning and mitigating the risk of talent poaching.

Sašo Papp:
Thank you, Teodora. Marija mentioned the importance of transparency. What would your advice be for other companies considering ESOP implementation? What to do to ensure transparency and effective communication with their employees regarding ESOPs? 

Teodora Bobcheva:
Well, my advice is, for companies considering employee stock ownership plan implementation, that they should prioritize clear and open communication from the start. So for example, this might include seeking input from employees with specific knowledge and roles in the company and from external experts during the design phase of the ESOP, so they can enhance buy-in and ensure that the plan meets the needs and expectations of all involved, and also to make sure that the plan is compliant with the regulatory framework. For example, another best practice is to identify the most appropriate individuals – such as members of the executive team, direct managers, members of the legal team, or a combination of these people – so they can communicate the ESOP details effectively to the employees. And of course, these individuals should be equipped with comprehensive knowledge about the plan and its mechanics, so they can address any questions or concerns from the employees. Another thing that companies can do is regular updates on the company's performance and the value of the ESOP shares, because this can also help keep employees engaged and motivated. This is mainly because employees can see that their work contributes to an increase in the company’s value, and as a result, this increases the value of their shares. Also, providing avenues for employees to ask questions and voice concerns fosters a culture of trust and transparency, and this also ensures the success of an ESOP programme. I can share that transparent communication is indeed crucial for the successful implementation of an ESOP, but what I think is more important for the management is to be able to accurately assess those who deserve such an honour. There is no doubt that companies should clearly communicate any specific requirements or actions that employees need to take to benefit from the ESOP, for example, selection processes, eligibility criteria, performance metrics, or vesting schedules. And although such communication is mandatory for publicly traded companies and large companies, I personally think that it somewhat negates the true purpose of an ESOP. Because the general idea, for me, behind an employee stock ownership plan is not that this is something taken for granted, but ESOPs are here to provide additional incentives for key employees to feel that they have been fairly compensated as their daily operations become a lot more strategic than trivial.

Sašo Papp:
OK, so clear and transparent communication is great, as always, right? And from what I can hear, there are so many factors to consider, basically. Marija, what advice would you give to companies looking to implement an ESOP in the CEE region?

Marija Tešić:
Well, my advice would be to start well in advance, and to involve legal and tax experts right from the planning stage, in order to understand all the specific legal and tax requirements in each country to which the ESOP refers, and to have the possibility to customize that as much as possible to the companies’ objectives. Additionally, as Teodora already explained, transparent and open communication should be a priority, and all necessary information and clarification should be available to them [the employees] to ensure that they are well informed and on board. 

Sašo Papp:
Thank you both for sharing your insights and experiences with us today. ESOPs seem to be a powerful tool for fostering employee engagement and ownership in companies throughout the CEE region also.

Marija Tešić:
It was my pleasure. An ESOP presents a very exciting opportunity, but remember to do good preparation work to navigate all the complexities if you wish to reach the desired outcome.

Teodora Bobcheva:
Yeah, I’d second Marija's advice, definitely.

Sašo Papp:
Thank you, everyone, for tuning in to our podcast episode on ESOP incentives in the CEE region. We hope this episode provided valuable information to both employers and employees considering ESOPs as part of their compensation and ownership strategies. If you missed any of our previous episodes, you can find them on our website or revisit them via your LinkedIn profile. Be sure to stay tuned for our upcoming episodes soon.