Employee Stock Options (ESOPs) Under CAMA 2020 for Nigerian Startups

Are you a Nigerian startup navigating the complexities of Employee Stock Options (ESOPs) Under CAMA 2020? The introduction of the Companies and Allied Matters Act (CAMA) 2020 brought significant reforms to the corporate governance landscape in Nigeria, especially impacting how startups implement ESOPs to attract and retain talent. The new regulation mandates that all shares be fully issued at incorporation, presenting challenges for traditional ESOP structures.
This article serves as a guide, offering clarity on how to structure Employee Stock Options (ESOPs) Under CAMA 2020 to ensure compliance while still leveraging the benefits of stock options.

In this article, you’ll discover:

Understanding the Shift: How CAMA 2020 changed the authorized share capital system and what it means for ESOPs.
ESOPs and the Law: How CAMA 2020 recognizes and supports ESOPs despite restrictions, referencing sections within the Act.
Structuring Solutions: Alternative legal structures, such as increasing share capital, share buybacks, and employee trusts, to effectively manage ESOPs.
Addressing Discounted Shares: An analysis of Section 146 of CAMA 2020, clarifying that ESOPs do not violate restrictions on issuing shares at a discount.
Ensuring Compliance: Practical steps for startups to structure ESOPs legally, including creating an ESOP pool via an Employee Trust or Holding Entity

Introduction

The introduction of the Companies and Allied Matters Act (CAMA) 2020 brought significant reforms to the corporate governance landscape in Nigeria. One of the most impactful changes is the requirement that all share capital must be fully issued at incorporation. This change has raised important concerns within the startup ecosystem, particularly regarding the implementation of Employee Stock Option Plans (ESOPs), which are critical for attracting and retaining talent.

Before CAMA 2020, companies could operate under an authorized share capital system, issuing only a fraction of their total authorized shares while reserving the rest for future use. This allowed startups to allocate shares for ESOPs without legal complications. However, the new regulation now mandates that all shares be fully issued at incorporation, effectively removing the ability to maintain unissued shares for stock option pools.

This shift has led to controversy among legal professionals and business stakeholders. Some argue that the new rule makes traditional ESOP structures impractical. The primary concern is that CAMA does not explicitly permit the reservation of shares for future allocation, which is a standard practice in startup financing worldwide. Without a dedicated stock option pool, startups face challenges in structuring incentives for employees without repeated corporate restructuring or capital increases.

As a startup attorney with a focus on corporate and commercial law, my position is that while the new provisions create obstacles, they do not eliminate the possibility of implementing Employee Stock Options (ESOPs) Under CAMA 2020. Instead, startups and their legal advisors must adopt alternative mechanisms within the framework of CAMA 2020 to ensure compliance while preserving the benefits of stock options. By leveraging solutions such as share capital increases, share buybacks, or the creation of employee trusts, Nigerian startups can continue to utilize ESOPs as a viable talent acquisition and retention strategy.

Understanding the Shift from Authorized Share Capital to Minimum Issued Share Capital

Under the repealed CAMA 1990, companies operated under an authorized share capital system, which allowed them to issue only a portion of their authorized shares (a minimum of 25%) while keeping the rest as unissued shares for future allotments. This flexibility enabled startups to reserve shares for ESOPs and investor stock pools.

However, CAMA 2020 replaced this system with the concept of minimum issued share capital. Under this framework, companies must issue their entire share capital at incorporation. For instance, if a company incorporates with a share capital of ₦10 million, all ₦10 million worth of shares must be issued immediately. Unlike before, companies can no longer hold back shares for future ESOPs or investor stock pools.

This new requirement poses a challenge, especially for startups, since investors typically want to see a pre-allocated stock option pool before committing funds. Without the ability to reserve shares for ESOPs, startups must find alternative methods to comply with CAMA while maintaining stock option pools.

Does CAMA 2020 Recognize ESOPs?

Despite these restrictions, CAMA 2020 does recognize and support ESOPs, as it explicitly references them in several provisions. For instance, Section 183(3)(b) allows a company to provide money for the purchase of fully paid shares for employees under an ESOP. This provision ensures that companies can financially support stock option plans, either by direct purchase or through a structured scheme. Similarly, Section 183(3)(c) allows companies to lend money to employees to enable them to buy shares, thereby facilitating stock acquisition without requiring employees to provide immediate capital.

Additionally, Section 186 grants companies the right to buy back shares from employees who obtained them through an ESOP. This ensures that businesses retain flexibility in managing their stock distribution while also providing a structured exit strategy for employees who leave the company. Furthermore, Section 189(b) specifically permits companies holding treasury shares to transfer them for ESOP purposes, enabling businesses to set aside shares for future employee allocations without violating the fully issued share requirement of CAMA 2020.

Section 431 further strengthens ESOP recognition by acknowledging employee entitlement to profit-sharing under an incentive scheme. This means that employees who hold stock options or shares in the company are legally recognized as stakeholders in profit distributions, whether or not dividends have been formally declared.

However, despite these legal acknowledgements, some legal professionals, argue that CAMA 2020’s requirement that all shares be fully issued makes traditional ESOP arrangements impractical and potentially unlawful. Their position is based on the fact that the Act does not explicitly allow for reserved stock pools, which are standard in startup funding and ESOP structures globally. This legal gray area makes it essential for businesses to carefully structure ESOPs in compliance with CAMA 2020.

How to Structure ESOPs Under CAMA 2020

Since companies can no longer reserve unissued shares, they must adopt alternative legal structures to create and manage ESOPs effectively.

Increasing Share Capital or Using Share Buybacks

One approach for startups is to increase share capital through a board and shareholder resolution and issue new shares when employees exercise their options. For example, if a company originally has ₦10 million issued share capital and has an ESOP agreement with an employee, it can increase its share capital and reallot new shares once the employee exercises their stock option after a cliff period at a determined strike price.

Key ESOP Terms Explained:

Cliff Period: The waiting period before an employee becomes eligible to exercise stock options.
Strike Price: The pre-agreed price at which employees can buy shares.
Exercise Option: The act of an employee purchasing shares under an ESOP after meeting required conditions.

Alternatively, the company can buy back shares from existing shareholders and reallocate them to employees under the ESOP. This is particularly useful if increasing share capital is not immediately feasible.

However, this method does not create a true reserved stock pool, as every increase requires a new approval process.

Setting Up an Employee Trust or Holding Entity

A more strategic and long-term solution is to set up an Employee Trust or Holding Entity to hold shares for ESOP allocations. Under this arrangement:

At incorporation, a portion of shares is issued to the Employee Trust or Holding Entity, which holds them as a stock option pool.
Employees receive options to acquire shares from this pool, avoiding the need to issue new shares each time.
When employees exercise their stock options, the trust transfers shares to them without requiring a fresh share capital increase.

This method ensures that the company maintains a structured ESOP plan without violating CAMA’s requirement for fully issued shares. It also aligns with various CAMA provisions, such as Section 183(3)(b), which allows funding for employee share purchases through trustees, and Section 189(b), which permits the use of treasury shares for ESOPs.

While CAMA 2020 eliminates the concept of unissued shares, making traditional ESOP structures more challenging, companies can still implement ESOPs through legal and strategic adjustments. I will recommend that Startups should consider Creating an Employee Trust or Holding Entity to hold and manage ESOP shares.

By adopting these approaches, Nigerian startups can continue to attract and retain key talent while staying compliant with corporate regulations.

Other Issues with ESOP Under CAMA 2020

The Companies and Allied Matters Act (CAMA) 2020 also introduced another legal question around Employee Stock Option Plans (ESOPs), particularly with Section 146, which deals with the restriction on issuing shares at a discount.

In 2023, Bloomfield, a law firm, reviewed Section 146 of CAMA and the creation and execution of Employee Share-Based Compensation Schemes (ESBCs) in Nigeria, noting that “a clear review of the Companies and Allied Matters Act 2020 (‘CAMA’), indicates that most ESBCs might be unlawful.”

From a startup advisory perspective, however, and based on how the legal mechanics of ESOPs work, ESOP remains lawful under CAMA. While Section 146 appears restrictive on the surface, a deeper analysis of its provisions and how ESOPs function in startup equity structures reveals that ESOPs can be structured legally under Nigerian law.

Understanding Section 146 and ESOPs

Section 146 of CAMA 2020 states that it is unlawful for a company to issue shares at a discount, which, at first glance, seems to create problems for ESOPs. However, this assumption is based on a misunderstanding of how stock options operate.

Startups often attract talent by offering stock options at a price lower than the current market value—a practice that might seem to contradict Section 146. However, the core issue is not market value but nominal value. The restriction under Section 146 applies only to issuing shares below their nominal (face) value, not their market value.

Distinguishing Share Market Value from Nominal Share Value

A startup attorney who understands startup fundraising mechanics and corporate structures knows the distinction between nominal and market value:

A company’s market value per share can be ₦2, while its nominal (face) value is only ₦0.02 (2 Kobo).
CAMA only prohibits issuing shares below nominal value, not below market value.

For example, when a startup progresses through funding rounds (e.g., Series A), investors purchase preferred shares at a negotiated price based on the company’s valuation. However, this price does not automatically determine the value of common shares held by the Company Founders for instance.

In other jurisdictions, such as the United States, companies conduct a 409A valuation to determine the fair market value (FMV) of common stock, which is used as the strike price or exercise price in stock option agreements. Nigerian startups can adopt a similar approach in structuring ESOPs.

Why ESOPs Do Not Violate Section 146

Beyond share valuation, ESOPs remain compliant with Section 146 for additional reasons:

Stock Options Are Not Share Issuance at Discount: Employees do not buy shares at issuance; they receive an option to purchase shares later at a predetermined strike price.
Shares Come from a Pre-existing ESOP Pool: The shares offered under an ESOP are often held in a trust or ESOP pool, rather than being newly issued at a discount.
Legal and Economic Rationale of Section 146: The prohibition on discounted share issuance exists to:
- Protect Shareholders and Creditors: Issuing shares below nominal value could weaken a company’s financial position and impact creditor confidence.
- Prevent Market Manipulation: If companies could arbitrarily issue shares at a discount, it could artificially lower valuations and harm investors.
- Ensure Fair Capital Raising Practices: The rule is designed to promote fair capital-raising activities, ensuring companies do not undervalue their shares.

ESOPs, however, are not a capital-raising mechanism but a talent retention strategy that CAMA explicitly recognizes.

Legal Structuring of ESOPs to Ensure Compliance

To ensure compliance with CAMA 2020, startups can structure ESOPs by:

Creating an ESOP Pool via an Employee Trust or Holding Entity: Shares are allocated at incorporation to a trust or holding entity, which holds them for employees.
Ensuring That Stock Options Are Exercised at Fair Market Value: Employees acquire shares at an exercise price determined through a proper valuation process.
Utilizing Treasury Shares for ESOPs: CAMA allows companies to hold treasury shares, which can be allocated to employees under an ESOP instead of issuing new shares.

Implications for SAFE Agreements

A strict interpretation of Section 146 could also cast doubts on SAFE (Simple Agreement for Future Equity) Agreements, which often involve granting early investors discounted shares in exchange for providing capital at an early stage. If discounts on shares were considered unlawful, it would invalidate many SAFE agreements commonly used in startup financing.

However, this interpretation would be impractical and contrary to the economic realities of venture capital and startup funding. As such, ESOPs and SAFE Agreements can still be legally structured under CAMA 2020, provided they adhere to the outlined frameworks.

Conclusion on Employee Stock Options (ESOPs) Under CAMA 2020?

While CAMA 2020 eliminates the concept of unissued shares, making traditional ESOP structures more challenging, companies can still implement ESOPs through legal and strategic adjustments. Startups should consider Creating an Employee Trust or Holding Entity to hold and manage ESOP shares. By adopting these approaches, Nigerian startups can continue to attract and retain key talent while staying compliant with corporate regulations.

Furthermore, while Section 146 of CAMA 2020 introduces restrictions on issuing shares at a discount, a nuanced understanding of nominal vs. market value and the structure of ESOPs ensures compliance. Employee stock options do not violate the provision because they are structured as future purchase options, not discounted share issuances. Similarly, SAFE Agreements remain valid when structured properly, ensuring that the startup ecosystem continues to thrive within the legal framework of Nigerian corporate law.

To learn more about Employee Stock Options (ESOPs) Under CAMA 2020 or simply issuing an ESOPs, I will refer you to Carta Resource on Issuing ESOPs.