Employee Stock Ownership Plans (ESOPS) and the Law in Kenya

Introduction

In the increasingly competitive Kenyan business environment, companies are constantly seeking innovative ways to attract, motivate, and retain talented employees. One of the most effective long-term incentive mechanisms is the Employee Stock Ownership Plan, commonly known as an ESOP. This article provides a comprehensive examination of ESOPs in Kenya, exploring their legal framework, tax implications, practical considerations, and the lessons emerging from recent case law.

An ESOP is a share incentive programme offered by companies to their employees, allowing them to acquire shares in the company where they work . By giving employees a stake in the business, ESOPs help create a stronger sense of ownership and connect individual contributions to the company’s long-term growth. For employers, this supports retention, motivation, and long-term thinking, particularly where traditional pay structures may not fully address the need to keep key talent engaged. For employees, it can strengthen commitment by allowing them to share in the value they help create.

This article is written for business owners, HR professionals, legal practitioners, finance officers, and employees who want to understand how ESOPs work in the Kenyan context. It will equip readers with practical knowledge about structuring ESOPs, navigating regulatory requirements, managing tax obligations, and avoiding common pitfalls. The discussion draws upon recent judicial decisions, regulatory pronouncements, and practical experiences from the Kenyan market.

Understanding ESOPs: What They Are and How They Work

The Core Concept

At its most basic level, an ESOP allows employees to acquire shares in the company they work for, either immediately or over a vesting period. Companies can issue new shares or allocate existing shares to an ESOP trust, with a defined plan governing eligibility, vesting schedules, and exercise terms . The objective is to align employee performance with the long-term success of the business. Unlike cash bonuses, employee share schemes encourage staff to think like owners.

Types of ESOPs

Kenyan legislation governing ESOPs includes the Companies Act 2015, the Trustees Act, common law, and the Capital Markets Authority Collective Investment Schemes Regulations, 2001 which govern ESOPs in listed companies. Given the undeveloped nature of the ESOP regulations in Kenya, United Kingdom statutory schemes regulations provide necessary guidance as to the structure of the main schemes used today. There are three main types of schemes in use in Kenya:

1. Profit Sharing Scheme

This is based upon a trust, which must be established for the purpose. The trustees receive payments from the company and apply these payments in acquiring the ESOP shares. These shares are then ‘appropriated’ by the trustees to eligible employees in accordance with the trust deed and rules of the scheme.

2. Savings-Related Share Option Schemes

This is linked to a savings contract. The eligible employees are offered options to subscribe for the ESOP shares with the price payable on exercise being fixed at the date on which the option is granted.

3. Share Option Scheme

Participants are granted options to acquire the ESOP shares. The subscription price is fixed at the date of grant of the option. There may be provisions requiring exercise of the option within strict time limits. For listed companies, the Capital Markets (Collective Investment Schemes) Regulations require ESOPs to be structured as an ESOP unit trust, with a trust deed, scheme rules, and CMA approval . Most early-stage startups use the simple share option scheme model .

Key Components of an ESOP

Every ESOP is comprised of several essential components that must be carefully considered and documented:

Vesting Period– The duration an employee must stay before acquiring full ownership of shares. This typically ranges from three to five years. In the Equity Bank case, the vesting period was deemed to be the fifth anniversary of the allocation of the units.

Exercise Price – The price at which employees can purchase shares, which may be at a discount.

ESOP Trust – The entity that holds shares on behalf of employees.

Dividends– Employees may receive dividends before or after exercising options.

Exit Strategy– Terms for employees selling shares back to the company or on the market.

Why Companies Establish ESOPs

Companies introduce employee share schemes for a variety of strategic reasons:

Retaining key employees – ESOPs create a financial incentive for employees to remain with the company to benefit from share appreciation over the vesting period.

Rewarding outstanding performance – Employees who contribute to company growth can share in the value they help create.

Aligning employee and shareholder interests – When employees own shares, their interests align with those of existing shareholders, encouraging decisions that enhance long-term value.

Reducing staff turnover – The prospect of share ownership can reduce costly turnover-related expenses.

Supporting succession planning – ESOPs provide a mechanism for business owners to transition ownership to employees over time.

Encouraging long-term business growth – Employees become invested in the organisation’s success, encouraging improved performance, innovation, and long-term commitment .

For start-ups and rapidly growing businesses, ESOPs provide a practical method of rewarding employees while preserving cash flow . However, employers should balance commercial objectives with tax and compliance requirements .

Legal and Regulatory Framework

Company Law Considerations

ESOPs in Kenya must comply with the Companies Act 2015, company constitutions, shareholder agreements, and corporate governance requirements. Before issuing employee shares, businesses should review their Articles of Association, ensure proper shareholder approvals, obtain board resolutions, and consider share capital structure and existing shareholder rights.

Capacity of the Company

A company may only establish an ESOP if it has the corporate power to do so under its memorandum and articles of association . Some companies provide for a specific power to establish an ESOP, but a more general power to remunerate employees should otherwise suffice. If the objects clause of the memorandum of association needs to be extended to enable the setting up of an ESOP, then the alteration needs to be made by a special resolution in line with the Companies Act 2015.

Availability of Authorised Share Capital

It is necessary for a company which adopts an ESOP to have sufficient authorised but unissued share capital for the allotment of shares under the scheme. If the authorised share capital is insufficient, it can be increased by an ordinary resolution of shareholders in accordance with Section 405 of the Companies Act 2015.

Financial Assistance

The Companies Act 2015 permits a company to provide financial assistance for the purchase or subscription of its shares with respect to setting up an ESOP. This financial assistance is available to employees or former employees, spouses, widows, widowers or surviving, or minor children or step-children of any such employees or former employees.

Shareholder Approvals

The recent HF Group case illustrates the importance of proper shareholder authorisation. HF Group shareholders passed a resolution on 28 May 2025 approving significant amendments to the company’s employee share ownership plans, including the transition from the 2008 scheme to a new structure aligned with the Companies Act 2015. Shareholders also granted the Board the authority to allot ESOP shares. The Capital Markets Authority subsequently granted approval for the issuance and listing of 94,274,401 new ordinary shares to the Trustees of the ESOP on 27 November 2025.

Regulatory Approvals

The regulatory landscape for ESOPs in Kenya includes several key approval requirements:

Capital Markets Authority (CMA) Approval – For listed companies, ESOPs must be approved by the CMA. The HF Group case demonstrates this requirement in practice, as the company sought and obtained CMA approval for the issuance and listing of ESOP shares.

Registrar of Companies Filings – Under the Companies Act 2015 and Companies (General) Regulations, share issuances require proper approvals and filings. When options are exercised and new shares are allotted, companies must file the return of allotment and any required updates on share capital and shareholding. ESOP shareholdings must be reflected in the company’s annual return. It is important to note that granting options normally does not require immediate filing; issuing shares on exercise does.

Board and Shareholder Resolutions– The process requires a board resolution approving the ESOP plan and documents, recommending to shareholders any increase in share capital or creation of a new share class. Shareholders must then pass a special resolution approving the establishment of the ESOP, any amendments to articles, and authority to allot ESOP shares.

The Trust Deed and Rules

The eligibility of employees, procedure of participating in the scheme, rules of exit, allotment, meetings and other rights and obligations of the parties are usually prescribed by the trust deed and the rules. A clause on the conditions of the vesting of the benefits must be provided for in the trust deed and the rules. It must be clear and notified to the participating employees . This will ensure fairness to employees and not result in instances where an employee feels short changed when they leave.

The key documents that should be prepared include:

(a) ESOP plan rules (b) ESOP trust deed (if using a trust) (c) Board resolution approving ESOP (d) Special resolution of shareholders approving ESOP and any changes to articles (e) Standard employee grant or option letter (f) Updated fully diluted cap table showing the ESOP pool

Employment Law Considerations

Under the Employment Act, it is important to make it clear that the ESOP is additional to statutory minimums under the Employment Act, not a replacement of wages or other minimum rights. Companies must also ensure that the ESOP does not discriminate unfairly on grounds such as gender, trade union membership, or other protected factors.

Tax Implications of ESOPs

Employee Tax Considerations

The taxation of ESOPs in Kenya has been the subject of fierce litigation and regulatory attention. In Equity Bank Kenya Limited v Commissioner of Domestic Taxes [2021] KEHC 8047 (KLR), the Kenya Revenue Authority (KRA) successfully claimed Kshs 234 million in PAYE from Equity Bank Kenya Ltd concerning ESOP benefits. The High Court upheld the Tax Appeal Tribunal’s decision allowing KRA to charge the Bank PAYE on Employee Stock Ownership Plan benefits.

The key principle established in this case is that an ESOP confers a benefit to an employee, and the benefit arises from the appreciation in value of shares at the time of vesting. The High Court agreed with KRA’s submissions that the ESOP confers a benefit to an employee and the benefit to the employee arises from the fact that value of shares, whether or not they are issued at a discount, would ordinarily appreciate at the time of vesting. The appreciation in value is the benefit to the employee that is taxed.

Under section 5(5)(a) of the Income Tax Act, the value of the benefit will be the difference between market price per share at the time of vesting and the offer price per share at the date an option is granted. In this respect, the benefit to the employee arises from the fact that value of shares, whether or not they are issued at a discount, would ordinarily appreciate at the time of vesting. The appreciation in value is the benefit to the employee that is taxed. The court found that Equity’s argument that it did not incur a cost to provide a benefit to its employees was not germane or relevant to the determination of the benefit to the employee under section 5(5)(a) of the ITA.

The practical implications for employees are as follows:

At Grant – There is usually no tax, since the option may not have a clear market value.

At Vesting or Exercise– The taxable benefit is typically the market value per share at vesting or exercise minus the offer or exercise price per share under the ESOP. This benefit is treated as employment income, subject to PAYE.

At Sale– When the employee later sells their shares, capital gains tax may apply on any further gain.

For registered ESOPs for listed companies, specific tax treatment may apply, while private company ESOPs are taxed under general inland revenue principles and KRA guidance.

Company Tax Considerations

From the company’s perspective, ESOPs offer several tax considerations:

(a) Administrative Cost Deduction– Companies can deduct ESOP setup, trustee fees, and legal costs.

(b) No Immediate Payroll Tax– Unlike cash bonuses, ESOP grants do not trigger PAYE until shares are exercised.

(c) Incentive Alignment– Retaining key employees via ESOPs can reduce costly turnover-related expenses, indirectly improving taxable profits.

Under the January 1, 2026 KRA regulation, ESOP-related transactions must be recorded with supporting eTIMS invoices for any exercise price payments or share buybacks. Expenses not documented in eTIMS are disallowed for tax purposes.

Accounting Treatment

The accounting treatment of ESOPs in Kenya should comply with the applicable financial reporting framework adopted by the company. Equity-based compensation affects both financial statements and corporate reporting. Businesses should consider fair value measurement, employee compensation expense, vesting schedules, share capital, equity reserves, and financial statement disclosures. Accurate accounting improves transparency and supports informed management decisions. Companies should maintain complete documentation supporting all accounting entries relating to employee share schemes.

Structuring an ESOP: A Step-by-Step Guide

Step 1: Determine the Objectives

Before implementing an ESOP, a company must clearly define its objectives. These may include retention of key staff, performance incentives, alignment of employee and shareholder interests, or succession planning. The objectives will shape the design of the scheme.

Step 2: Legal and Regulatory Compliance

The company must ensure the ESOP is structured in compliance with the Companies Act 2015, align with IFRS 2 for share-based payments, and file required returns with KRA while maintaining eTIMS compliance. This requires engagement with legal and tax advisers.

Step 3: Design the Scheme

The company must decide on the type of scheme to adopt, the size of the share pool, eligibility criteria, vesting schedule, exercise price, and exit provisions.

Key terms to cover in the ESOP plan rules include:

(a) Eligibility (which employees and when) (b) ESOP pool size and individual limits (c) Vesting schedule and cliff (d) Exercise price and exercise window (e) Good and bad leaver rules (f) Treatment on death, disability, resignation, dismissal, or redundancy (g) Treatment on sale of the company or new funding rounds (h) Confidentiality and IP protection reminders (i) Dispute resolution and governing law (Kenya)

Step 4: Draft ESOP Documents

The company must prepare comprehensive documentation, including ESOP plan rules or scheme rules, board and shareholder resolutions, individual grant or option letters, and, if using a trust, an ESOP trust deed and trustee appointment.

Step 5: Obtain Corporate Approvals

The company must obtain a board resolution approving the ESOP plan and documents, a shareholders’ special resolution approving the establishment of the ESOP and any amendments to articles, and, if required, CMA approval.

Step 6: Consider Tax Implications

The company should work with a tax adviser to document how fair market value will be determined at exercise, especially for private companies, and set a process for correct PAYE deduction and reporting when options are exercised. The company should also communicate clearly to employees that there may be a tax bill on exercise and how the company will handle PAYE, for example, through a sell to cover arrangement or deduction from salary.

Step 7: Communicate, Implement, and Maintain the ESOP

Even a perfectly drafted ESOP will fail if employees do not understand it. Companies should run short ESOP workshops or Q&A sessions to explain what options are, vesting and cliffs, that there is no guaranteed exit, and basic tax implications. They must also maintain clear records, including an ESOP register showing grants, vesting status and exercises, copies of all grant letters and acceptances, and minutes of board and shareholder approvals.

Lessons from Recent Case Law

Equity Bank ESOP Dispute

The case of Kamiti v Equity Bank Limited & 6 others (Civil Appeal 662 of 2019) [2025] KECA 1761 (KLR) provides important lessons for both employers and employees regarding ESOPs. The case involved an employee who resigned from Equity Bank and claimed entitlement to ESOP shares. The rule at issue provided that an employee who ceased to be an employee of the bank for whatever reason, before the vesting date of his shares, deemed to be the fifth anniversary of the allocation of the Units, was not permitted to, or deemed to have given a Redemption Notice. The employee would forfeit all such Units without any right to compensation.

The appellant asserted that the Deed of Variation was not discussed with him or brought to his attention. He claimed that the Deed of Variation received the sanction of the first respondent at the annual general meeting held on 26th March 2010, and the Capital Market Authority only received the said Deed of Variation on 4th May 2010 for approval. The appellant sought a declaration that the purported amendment of the Settlement Deed dated 29th August 2005 by introducing a vesting date with effect from the 11th November 2009 was illegal, null and void.

The respondents asserted that the Variation of the Deed was effected on 11th November 2009 when the appellant was still in the employment of the first respondent and the provisions of the Variation are binding on him. They argued that there was a meeting of the staff of the first respondent held in Nyeri at the time of the inception of ESOP, which agreed that the minimum period of service before vesting of units would be five years. They later sought and obtained approval from the Capital Markets Authority.

The appellant testified that he was not aware that the Trustees could amend the Trust Deed from time to time and that the first respondent failed to credit into his account the value of his Units and instead credited Kshs. 24 million which was a mere refund. He also stated that the Trustees did not call him to inform him of the variation, and he was never provided with the Trust Deed despite his request via email to the company secretary.

Key lessons from this case include:

(a) The importance of clearly communicating ESOP terms and any variations to participating employees

(b) The need for proper documentation and approval of amendments to ESOP trust deeds

(c) The potential for disputes when employees leave before shares vest

(d) The critical role of the Capital Markets Authority in approving ESOP variations for listed companies

Globology ESOP Dispute

In Neser v Globology Limited & 7 others (Cause E033 of 2024) [2025] KEELRC 1777 (KLR), the Employment and Labour Relations Court addressed a dispute concerning ESOP allocation. The claimant asserted that under Clause 8(x) of the Globology ESOP Trust Deed, the Trustees had full discretion to allocate shares under the ESOP rules. He contended that their refusal to allocate shares to him amounted to abuse of this discretion. He also asserted that it was vital to pierce the corporate veil due to the directors’ misuse of corporate structures.

The claimant relied on the cases of Jones v Lipman [1962] 1 All ER 442 and H.L. Bolton (Engineering) Co. Ltd v T.J. Graham & Sons Ltd [1956] 3 All ER to demonstrate that the directors who control the company represent its “mind and will,” and that their misconduct can justify treating them as one with the company.

Key lessons from this case include:

(a) Trustees have discretion in allocating ESOP shares, but this discretion must be exercised properly

(b) Allegations of abuse of discretion can lead to litigation and potentially piercing the corporate veil

(c) ESOP trust deeds must clearly define the scope of trustee discretion

Practical Questions to Consider Before Adopting an ESOP

Before implementing an ESOP, companies should carefully consider several questions:

Will the succession plan in place get the most out of your company? Having an ESOP will ensure a seamless succession plan since it is attributed to improved productivity, profits and share value. The participating employees in ESOPs give their best to the company since their interests are in line with those of the management and shareholders.

Is your company big enough? To establish an ESOP, a company is going to need an advocate, a valuation expert, and a trustee for the ESOP programme. Then, there are continuing compliance and costs for tax returns and annual valuations.

Are you ready to share your financials? At the very least, you will have to allow the participating employees access to the audited accounts of the company.

What type of ESOP is appropriate for your company? This depends on the company’s size, structure, objectives, and whether it is listed or private.

What will be the tax impact on employees? Companies must consider how ESOP benefits will be taxed and communicate this clearly to employees.

How will the ESOP affect existing shareholders? Issuing new shares will dilute existing shareholders, and this must be carefully managed.

ESOPs for Startups

For startups in Kenya, ESOPs provide a practical method of rewarding employees while preserving cash flow. However, the regulatory landscape is evolving, and startups must navigate specific considerations.

The proposed Finance Bill 2025 changes, if implemented, would significantly affect startup ESOPs. The government proposed to scrap tax breaks on employee stock ownership plans for early-stage startups.

Under the current rule, passed under the Finance Act 2023, employees at eligible startups could defer tax until five years after receiving shares, or when they left the company or sold their stake. The new proposal would unwind that deferral and force workers to pay income tax within 30 days of receiving shares, regardless of whether those shares can be sold .

For early-stage startups, liquidity is rare and valuations can often be speculative, meaning that such a move could amount to taxing promise rather than profit. Employees taxed on their stock awards could theoretically benefit later through dividends or capital gains; however, most startup shares are unlisted and highly illiquid.

Despite these challenges, ESOPs remain an important tool for startups to attract and retain talent. Companies considering an ESOP should think carefully about the plan’s objectives, employee eligibility, communication approach, and tax implications before implementation. Getting these elements right from the start can help reduce surprises and improve employee confidence in the arrangement.

Best Practices for ESOP Implementation

Based on the legal framework, regulatory requirements, and lessons from case law, the following best practices are recommended:

1. Engage Professional Advisers– To establish an ESOP, a company needs an advocate, a valuation expert, and a trustee for the ESOP programme. Professional advisers should review the structure before implementation.

2. Document Everything – Clear documentation reduces misunderstandings between employers and employees. Companies should prepare comprehensive ESOP plan rules, trust deeds, grant letters, and board and shareholder resolutions.

3. Communicate Clearly with Employees– Companies should run ESOP workshops or Q&A sessions to explain the terms, conditions, tax implications, and risks of the ESOP. Clear communication reduces the risk of disputes when employees leave.

4. Maintain Proper Records– Companies must maintain an ESOP register showing grants, vesting status, and exercises; copies of all grant letters and acceptances; and minutes of board and shareholder approvals.

5. Review the ESOP Annually– Companies should review the ESOP annually to ensure the pool size still makes sense after new funding rounds and that the scheme remains competitive.

6. Ensure Tax Compliance– Companies must work with tax advisers to document how fair market value will be determined, set processes for correct PAYE deduction and reporting, and maintain eTIMS compliance for ESOP-related transactions.

Conclusion

Employee Stock Ownership Plans represent a great tool for Kenyan businesses to attract, motivate, and retain talented employees. They align employee interests with those of shareholders, encourage long-term thinking, and provide a mechanism for employees to share in the value they help create. However, ESOPs are complex arrangements that require careful planning, proper documentation, and ongoing compliance with legal and regulatory requirements.

The Kenyan legal framework for ESOPs is evolving, with the Companies Act 2015, Capital Markets Authority regulations, and KRA tax rules all shaping how ESOPs must be structured and administered. Recent judicial decisions, particularly the Equity Bank and Globology cases, highlight the importance of clear communication, proper documentation, and fair treatment of employees. They also underscore the significant tax implications that can arise from ESOP benefits.

For companies considering an ESOP, the key to success lies in proper planning. This means engaging professional advisers, clearly defining objectives, carefully designing the scheme, obtaining all necessary approvals, communicating effectively with employees, and maintaining rigorous compliance with tax and regulatory requirements. Companies should also be aware of the evolving regulatory landscape, including proposed changes that could affect the taxation of ESOPs for startups.

For employees, understanding the terms of an ESOP is essential. This includes knowing the vesting schedule, exercise price, tax implications, and what happens if they leave the company before shares vest. Employees should seek clarification of any terms they do not understand and should be aware that the benefit from an ESOP is taxable as employment income.

Ultimately, a well-designed and properly implemented ESOP can create a “win-win” scenario for both employers and employees. Employees become invested in the organisation’s success, while employers benefit from improved retention, motivation, and long-term commitment from their workforce. As Kenyan businesses continue to compete for skilled talent, ESOPs will increasingly become an essential component of a comprehensive compensation strategy.

Authored by Benson Odiwuor Otieno Advocate, High Court of Kenya

This article is a publication of the Litigation Practice Notes series, featured in The BOLD Newsletter. For questions, clarifications, or suggestions on this or related subjects, contact the author directly: insights@bensonodiwuor.com / info@benodiwuor.com.