Employee Share Option Plans or Employee Stock Ownership Plans (ESOPs) are a unique way to provide your employees with additional benefits and interests in the company. They are also a great way to motivate and align the interests of employees with those of the company and shareholders. That’s because, with stock in the company, employees are also shareholders.
This article will explain what ESOPs are and why you should consider them as part of your benefits strategy.
Plans are and why you should consider them.
Table of Contents
What are Employee Share Option Plans (ESOPs)?
Employee Share Option Plans are employment benefit plans that give employees an ownership interest in the company. They are commonly referred to as ESOPs.
In Australia, ESOPs typically grant equity to employees in the form of share options, which can be vested over time and eventually purchased at fair market value. This structure provides employees with a sense of ownership and a personal interest in driving value for their company.
Employees receive shares in the company as a non-cash benefit. Unlike traditional incentive plans like bonuses or salary increases, employees get a stake in the company’s long-term success. At the same time, ESOPs are not a one-time reward; instead, they offer the potential for ongoing financial benefits as the company grows.
How do ESOPs work?
There are several key steps to implementing an employee share option plan in Australia. Here are some things you need to consider.
Share allocation
First, you’ll need to set aside a portion of your company’s shares for the ESOP. These allocated shares may be held in a trust on behalf of the employees. This makes sure that the stock is properly managed and distributed as you begin awarding shares to employees. Alternatively, some schemes issue shares directly to employees as needed.
Vesting schedules
Employees receive share options that vest over a specified period, usually ranging from 3 to 5 years. This means that your employees gain gradual access to their stocks. This gradual vesting encourages employee retention and increased interest in your company’s success.
Exercise of options
Once the vesting period is complete, employees can exercise their options and purchase shares. The purchase price is often set at a discount to the current market value, providing an immediate benefit to employees.
Share ownership
After exercising their options, employees become shareholders in the company. Depending on the specific plan structure, they may receive dividends and voting rights. Such involvement will help further build their sense of ownership and engagement with the company.
Exit provisions
When employees leave the company, there are typically provisions in place requiring them to sell their shares back to the company. This ensures that ownership remains with current employees and maintains the integrity of the ESOP structure.
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Benefits of ESOPs for employers and employees
An employee stock ownership plan can prove to have many benefits for the wider company and its workforce. Employers benefit in the following ways:
- Offsetting the costs of employee benefits packages as your business grows
- Motivating better performance by giving your staff a stake in the company’s success
- Retaining employees by increasing their commitment to the business
- Building and supporting your company’s culture
By having a shared interest in the company, your company’s performance has a direct impact on employee remuneration and benefits. When the company performs well, so do your employee’s shares. This way, there is a direct link between employee performance and remuneration.
In this same way, stock ownership plans are great for aligning the interests of employees with those of shareholders. This encourages employees to act in a way that has the best interests of the shareholders since they themselves are shareholders.
ESOPs also offer several advantages to employees.
- Financial incentives: Employees can benefit directly from the company’s success through share price appreciation and potential dividends.
- Ownership mindset: ESOPs foster a sense of ownership, leading to increased job satisfaction and engagement.
- Long-term wealth creation: As the company grows, employees can build significant wealth over time.
For example, an employee at a tech startup might receive options that vest over four years. If the company’s value increases significantly during this period, the employee could get a lot in return when they exercise their options.
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Eligibility and criteria for ESOPs
Who is eligible for ESOPs will depend on your employee share option plan and other company policies. In some schemes, ESOPS are restricted to full-time employees and only allocated to key personnel or executives. Some companies offer wider access to shares, in some cases to all staff, even those on part-time or casual contracts.
Common conditions for ESOP eligibility may include:
- Minimum length of service (e.g., 12 months)
- Performance criteria
- Position within the company
It’s important to note that in Australia, Startup concession ESS must offer at least 75% of your full-time employees with 3 years of tenure. However, these limitations do not exist for ESOPs at the moment despite their similarities (more on this later).
Taxation of ESOPs in Australia
Significant changes over the past decade in Australia’s ESOP taxation have made them more attractive to employees and startups. The Startup Concession ESS was enacted on 1 July 2015 and has proven very popular for new businesses. Here are some key points to keep in mind when considering whether a Startup Concession ESS is right for your business.
- Tax deferral: Employees can defer tax for up to 15 years or until they sell their shares
- Capital gains tax: When shares are sold, any increase in value may be subject to capital gains tax which can result in a lower tax bill than normal income.
- Employer reporting: Companies must report when they issue employee share options to the Australian Taxation Office (ATO).
For example, if an employee exercises options to purchase shares at $10 per share when the market value is $15, they wouldn’t be taxed on the $5 difference immediately. Instead, the tax would be deferred until they sell the shares and realise a profit.
How ESOPs are different from Startup Concession Employee Share Schemes (ESS)
While ESOPs and Employee Share Schemes (ESS) are both forms of employee ownership, they have some key differences.
| Aspect | ESOP | Startup Concession ESS |
| Structure | Offers share options | Issues shares directly |
| Eligibility | Can be offered to any number of employees | At least 75% of full-time employees with 3 years tenure must be eligible |
| Employee engagement | Requires employees to vest options | No engagement required |
| Immediate benefits | No immediate dividends or voting rights | Immediate dividends and voting rights |
| Tax treatment | Tax can be deferred for up to 15 years | May have different tax implications |
ESOPs generally offer more flexibility in terms of who can participate and how the plan is structured, while Startup Concession ESSs provide more immediate benefits to employees with a potentially better tax outcome.
Recent changes to ESOPs in Australia
Recent legislative updates have made ESOPs more attractive in Australia:
- Tax deferral: Since July 1, 2015, employees can defer tax on share options for up to 15 years.
- Startup concessions: The ATO introduced the Start-up Concession in 2015, reducing tax liability for employees’ shares in eligible startups.
- Increased flexibility: Changes in regulations have allowed for more flexible ESOP structures, benefiting both employees and startups.
These changes aim to encourage more companies, especially startups and small businesses, to implement ESOPs as a way to attract and retain talent.
How to implement an ESOP in your business
Implementing an ESOP in your business involves several key steps. Here is a summary guide.
- Discuss the guidelines for your company’s ESOP with your management team and the board.
- If necessary, seek independent advice from consulting firms experienced in ESOPs, including taxation and legal requirements.
- Workshop the recommendations with key stakeholders to reach a consensus on your ESOP plan.
- Prepare a recommendation for approval from the senior leadership team and the board.
- Draft the necessary documentation, including plan rules, offer documents, and explanatory materials.
- Obtain final approval from the board to proceed with implementation.
- Educate employees about the ESOP through explanatory booklets, workshops, and Q&A sessions.
- Launch the ESOP and manage ongoing administration, potentially using specialised ESOP software solutions.
Throughout this process, it’s crucial to ensure compliance with Australian laws and regulations, including ATO guidelines and corporate law requirements.
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FAQ
What happens to ESOP when you quit?
When you quit, you typically need to sell your shares back to the company. The specific terms, including the buyback price and timing, will depend on your company’s ESOP agreement.
Are ESOPs good or bad?
ESOPs can be good for both employees and employers as they offer potential financial benefits and increased engagement. However, they also come with risks; for example, share value could decrease.
What are the risks associated with ESOPs?
The main risks of ESOPs include potential loss of value if the company performs poorly, lack of diversification if too much of your wealth is tied to one company, and potential tax implications.
Final thoughts
ESOPs offer your Australian business a powerful tool to bolster your employee benefits package and align your staff’s interests with those of your company. When employees have a stake in the business’s future, they will be more motivated to stay long-term.
However, implementing an ESOP requires careful planning and expert guidance to navigate the legal and financial complexities. If you’re considering an ESOP for your business, check out Lawpath’s ESOP documentation to simplify the implementation process.
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