Nigerian startups operate in an increasingly globalised and competitive talent market. Experienced technical, product, finance, and commercial professionals now have access to opportunities with local companies, foreign startups, remote-first employers, and global technology businesses. For many startups, cash compensation alone is no longer sufficient to attract and retain senior talent. This is where Employee Share Schemes (ESS) become important.
When properly structured, an ESS can help a company conserve cash, reward long-term contribution, and align employees with the company’s growth. However, when poorly designed, it can create misunderstanding, tax exposure, cap table complications, and governance disputes.
Employee equity should, therefore, not be treated merely as an HR incentive. It is also a legal, tax, governance, and capital structure decision. This Tech Brief examines the principal ESS structures used in Nigeria, key design considerations, and practical governance requirements for founders and boards.
1. Why Employee Share Schemes Matter
At their core, ESS arrangements serve three strategic purposes:
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Retention: Vesting schedules tie employee tenure to long-term commitment.
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Interest alignment: Equity links employee performance to company value creation.
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Capital efficiency: Startups compete for talent without heavy cash burn.
However, equity is only effective where employees understand what they are receiving, when they may benefit from it, what tax consequences may arise, and what happens if they leave the company before an exit or liquidity event.
2. Choosing The Right Structure
There is no single model that works for every company. The appropriate structure will depend on the company’s stage, valuation, shareholder arrangements, tax position, governance framework, and long-term funding plans.
i. Employee Share Option Plan (ESOP)
An Employee Share Option Plan gives eligible employees the right to acquire shares in the company at a specified exercise price after certain vesting conditions are satisfied.
This structure is commonly used by early-stage companies because it allows employees to participate in future upside without the company issuing shares immediately. Until the options are exercised, the employee does not usually become a shareholder, and the cap table remains cleaner.
However, options are most attractive where the company’s value increases after the grant date. If the exercise price is higher than the fair market value of the shares at the time of exercise, the options may become commercially unattractive. This is often described as the options being “underwater.”
For that reason, companies should avoid overpromising the value of options. Employees should understand that options are not the same as cash and may not produce value unless the company grows, raises capital on favourable terms, or achieves a liquidity event.
ii. Restricted Stock Unit (RSU) or Share Grant
Restricted Stock Units are a promise to deliver actual shares once vesting conditions (typically performance conditions) are met. Unlike ESOPs, employees do not pay an exercise price to acquire shares. When RSUs vest, the shares are automatically deposited into the employee’s account, making RSUs simpler to understand than options.
RSUs are typically more suitable for later-stage or valuation-stable companies, where the risk of underwater grants is reduced.
However, RSUs can create tax and administrative issues because the employee may be taxed when the shares vest, even where there is no immediate liquidity to fund the tax obligation. This should be addressed clearly in the plan documentation.
iii. Employee Share Purchase Plan (ESPP)
An Employee Share Purchase Plan allows employees to acquire company shares at a discount, typically funded through payroll deductions over a defined period. Many plans include a “look-back” feature, allowing employees to purchase shares at the lower of the price at the beginning or end of the offering period, thereby enhancing potential returns.
This structure is more common in mature companies and listed companies because there is usually a clearer basis for valuation and a more realistic path to liquidity. In private startups, ESPPs may be less practical because employees may not have a ready market to sell the shares, and the company may not have a standardised valuation framework.
In Nigeria, companies must also consider the prohibition against issuing shares at a discount. Any discount must, therefore, be structured carefully and should not result in the shares being issued below their nominal value.
iv. Phantom Share Scheme (PSS)
A phantom share scheme grants employees a contractual right to receive cash payments tied to the company’s valuation or exit outcomes, without issuing actual shares. They do not dilute the cap table or confer shareholder rights, but replicate equity-like upside through cash settlement. This structure is typically used where founders seek to preserve ownership control, avoid the regulatory and administrative burden of share issuance, and still align employee incentives with company performance. However, it introduces a future cash liability, which must be carefully modelled against projected exits and liquidity to avoid balance sheet strain.
v. Stock Appreciation Rights (SARs)
Stock Appreciation Rights work like phantom shares, except the reward is tied specifically to appreciation rather than total valuation or exit outcomes. They grant employees the right to receive an increase in share value over a set period, without buying or holding the underlying shares. Employees earn the gain between the grant price and the value at exercise, settled in cash or shares. SARs are especially popular among early-stage companies that look to reward value creation without ceding ownership.
As with phantom shares, the company should carefully consider the funding, accounting and tax implications of the scheme.
3. Key Design Considerations
The effectiveness of an ESS depends not only on the incentive instrument selected, but also on the underlying legal, tax, and governance framework supporting it. Key considerations include:
i. Pool Sizing
Startups often reserve an equity pool for employee incentives. The size of the pool will depend on the company’s stage, hiring needs, valuation, and investor expectations. At early stages, companies may reserve a pool sufficient to attract key hires before the next funding round. At later stages, investors may require the pool to be refreshed or expanded before completion of an investment.
Founders should pay close attention to whether an option pool increase is calculated pre-money or post-money. If the pool is increased pre-money, the dilution is usually borne by existing shareholders. If calculated post-money, the dilution may be shared with incoming investors. This can have significant economic consequences.
ii. Vesting Schedules
The common market approach is a four-year vesting period with a one-year cliff. Under this model, no equity vests until the first anniversary of the grant date. After that, a portion vests, with the balance vesting periodically over the remaining period.
Vesting should be clearly drafted. The plan should state when vesting begins, how frequently vesting occurs, whether vesting is time-based or performance-based, and what happens if the employee leaves before the end of the vesting period.
For senior hires, a hybrid approach may be appropriate. This may combine time-based vesting with performance milestones linked to measurable targets.
iii. Acceleration on Exit or Change of Control
Companies should also consider what happens to unvested equity if there is a merger, acquisition, restructuring, or other change of control. A single-trigger acceleration allows some or all unvested equity to vest upon a change of control. A double-trigger acceleration requires both a change of control and a qualifying termination, such as termination without cause within a defined period.
Investors often prefer double-trigger acceleration because it preserves the retention purpose of the equity plan during a transaction. Founders and employees may prefer more favourable acceleration rights. The correct position will depend on the company’s bargaining position, stage, and investor profile.
iv. Eligibility and Participation
The plan should clearly identify who may participate. Some schemes are limited to full-time employees. Others may include directors, consultants, advisers, or contractors.
If non-employees are included, the documentation should address the legal, tax, and regulatory consequences. Companies should also consider whether granting equity or equity-like rights to contractors may affect the classification of the relationship.
v. Leaver Provisions
Leaver provisions are critical. They determine what happens when a participant exits the company. A good leaver may include an employee who leaves because of redundancy, retirement, ill-health, death, or another approved circumstance. Good leavers may be allowed to retain vested rights, subject to an exercise window.
A bad leaver may include an employee dismissed for fraud, gross misconduct, material breach, or other serious cause. Bad leavers may forfeit unvested rights and, depending on the plan terms, may also lose vested but unexercised rights.
These provisions should be drafted carefully. Overly aggressive leaver provisions can create disputes and may undermine employee trust in the scheme.
4. Tax Considerations
Tax treatment is central to ESS design. For employee share options, the primary tax event generally occurs when the employee exercises the option and acquires the underlying shares. The difference between the Fair Market Value (FMV) of the shares on the exercise date and the exercise price paid by the employee is treated as employment income and subject to PAYE at the applicable graduated rates. Employers are responsible for withholding and remitting the tax. Accordingly, ESS rules should clearly specify how this tax liability will be satisfied, whether through a cash payment by the employee, a withholding of shares, or the sale of a portion of the shares to fund the applicable tax obligation.
Accurately determining the FMV of shares is critical, particularly for private companies. While listed companies can rely on prevailing market prices, unlisted companies typically determine value based on their net asset position and issued share capital. A clear and defensible valuation methodology is, therefore, essential to mitigate tax and compliance risks.
For RSUs and share grants, tax may arise when the shares vest or are delivered to the employee. For phantom shares and SARs settled in cash, tax may arise when the cash payment is made or becomes due.
Employees should also be informed that a future disposal of shares may trigger capital gains tax, subject to applicable exemptions, thresholds, and reinvestment reliefs under Nigerian tax law.
5. Share Capital and CAMA Considerations
Following the abolition of authorised share capital under the Companies and Allied Matters Act, 2020 (“CAMA”), companies cannot reserve unissued shares for future employee grants. All shares must be allotted to identifiable shareholders at all times. This means a company cannot simply retain unallotted shares for a notional employee Share Option/Grant pool and draw from it as employees join or vest. Instead, the ESS must be structured using an alternative mechanism. Common approaches include:
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Employee Share Trusts or Special Purpose Vehicles (SPVs), where a block of shares is issued to a trust managed by a founder, staff representative(s) or SPVs to hold on behalf of future employee beneficiaries.
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Treasury Shares, where eligible companies repurchase and hold shares for future reissue under the ESS, subject to the requirements of CAMA 2020.
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Just-in-Time Share Issuances, where shares are only created and allotted when employees exercise vested options.
The appropriate structure will depend on the company’s growth stage, funding position, administrative capacity, and long-term equity incentive strategy.
6. Practical Checklist for Founders and Boards
Before launching an Employee Share Scheme, companies should:
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determine the commercial purpose of the scheme;
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decide whether the scheme will use options, RSUs, share grants, ESPPs, phantom shares, or SARs;
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define eligibility and participation rules;
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determine the size of the employee equity pool;
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review the articles of association and shareholders’ agreement;
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obtain board and shareholder approvals where required;
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prepare the scheme rules, grant letters, and supporting documentation;
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establish a valuation methodology;
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address tax withholding and reporting obligations;
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define good leaver and bad leaver consequences;
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clarify treatment on termination, acquisition, restructuring, or IPO;
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maintain accurate records of grants, vesting, exercises, and dilution.
7. Conclusion
Employee Share Schemes can be powerful tools for attracting, retaining, and motivating talent. For Nigerian startups, they can also help manage cash constraints while giving employees a meaningful stake in long-term value creation.
However, their effectiveness depends on careful structuring. The wrong design can create tax exposure, employee dissatisfaction, dilution disputes, and cap table complications. Founders and boards should therefore approach ESS design as a legal, tax, governance, and capital management exercise, not merely as a compensation policy.
