A Comprehensive Guide to Employee Share Ownership Plan (ESOP) Legal Structure in Australia

Australia’s tight labor market has spurred companies to explore innovative strategies. Employee Share Ownership Plans (ESOPs) have emerged as a powerful tool to attract, retain, and motivate top talent. Watch our free webinar to find out how ESOP can increase staff engagement and safeguard the future succession of your business.

But unlocking the full potential of ESOPs hinges on choosing the right legal structure. You will need to choose wisely to maximise tax benefits and improve employee engagement. By equipping yourself with this knowledge, you can navigate the complexities with confidence and design an ESOP that perfectly aligns with your company’s unique needs and goals.

Here’s an overview of the legal structures typically used for ESOPs in Australia:

Trust Structure

One of the most common methods for implementing an ESOP in Australia is through a trust structure. Here, an ESOP trust is established to hold the shares on behalf of the employees. This structure is particularly beneficial for tax deferral and can be flexible regarding how and when employees receive shares.

In Australia, an Employee Ownership Trust (EOT) is a structure used to facilitate employee ownership of a company. This structure is relatively new in Australia (Succession Plus set up the first one in 2006) compared to other countries like the UK. Still, it’s gaining popularity as a means of transferring ownership of a business to its employees.

Legal Structure of an Employee Ownership Trust

Here’s a breakdown of the legal structure and considerations for an Employee Ownership Trust in Australia:

• Establishment of the Trust: An EOT is a particular type of trust. This involves creating a trust deed, which outlines the rules governing the trust, including its purpose, how it will operate, and the rights and obligations of the trustee and beneficiaries (the employees).
• Appointment of a Trustee: The trust must have a trustee, an individual, a group of individuals, or a corporate trustee. The trustee is responsible for managing the trust’s assets (usually shares in the company) on behalf of the beneficiaries.
• Transfer of Shares: Shares in the company are transferred to the trust. This can be done in various ways, such as the owner selling or gifting shares to the trust or the trust purchasing shares. The funding for share purchase can come from different sources, including company profits or external financing.
• Beneficiaries: The beneficiaries of the trust are the employees of the company. The trust deed specifies the criteria for an employee to become a beneficiary and the extent of their beneficial interest.
• Distribution of Benefits: The trust can distribute benefits to the employee beneficiaries. This could be in the form of dividends from the shares held or potentially the allocation of shares themselves, depending on the structure of the trust and its rules.

EOTs represent an innovative way to transition ownership of a company to its employees, fostering a culture of shared ownership and aligning the interests of employees with the success of the business. However, setting up an EOT requires careful planning, a clear understanding of legal and tax implications, and strategic management to realise its full benefits.

Direct Ownership

In this structure, shares are issued directly to employees. This can be done by offering new shares or existing shares. Direct ownership is straightforward but does not offer the same tax deferral benefits as the trust structure and provides very little asset protection.

Loan Funded Share Purchase Plans

Under this arrangement, employees are loaned funds by the company to purchase shares. This can be structured in various ways, often including provisions where the loan is gradually forgiven as long as the employee remains with the company.

A loan-funded share plan is a type of employee share ownership plan (ESOP) in Australia where employees are provided with a loan from the company to purchase shares in the company. This arrangement allows employees to become shareholders and participate in the company’s growth and success.

Legal Structure of a Loan-Funded Share Plan

The legal structure of a Loan Funded Share Plan in Australia involves several key components:

• Plan Establishment: The company establishes the plan, outlining the terms and conditions under which shares will be offered to employees. This includes eligibility criteria, the number of shares available, the price of shares, and the loan terms.
• Employee Participation: Eligible employees are offered the opportunity to participate in the plan. Employees who choose to participate enter into an agreement with the company, which includes the terms of the share purchase and the loan.
• Loan to Employees: The company provides a loan to the participating employees to purchase shares. The terms of the loan, such as interest rate, repayment schedule, and duration, are specified in the agreement.
• Purchase of Shares: Using the loan provided, employees purchase shares in the company. The shares can either be newly issued shares or existing shares bought from the market or other shareholders.
• Repayment of Loan: Employees repay the loan to the company over time, according to the agreed-upon schedule. Repayments can sometimes be facilitated through deductions from the employee’s salary.
• Share Ownership and Rights: Once the shares are purchased, employees become shareholders and typically have the same rights as other shareholders, such as voting rights and the right to receive dividends.
• Loan-funded share plans can effectively engage employees and align their interests with the company’s. However, they require careful planning and management to navigate the legal, tax, and regulatory landscape effectively.

Option Plans

Option plans give employees the right, but not the obligation, to purchase shares at a predetermined price after a certain period. This is a popular choice, especially for startups, as it provides employees with potential future benefits without immediate tax implications.

Option plans are a popular Employee Share Ownership Plan (ESOP) type in Australia. They provide employees with the right, but not the obligation, to purchase shares in their employer’s company at a predetermined price after a certain period.

Legal Structure of Option Plans

This section delves into the legal structure and critical considerations for option plans in Australia:

• Grant of Options: The company grants employees options, giving them the right to purchase shares at a specified price (the exercise price) within a set timeframe.
• Vesting Period: Options often come with a vesting schedule, meaning employees earn the right to exercise their options over a period of employment.
• Exercise of Options: Once vested, employees can exercise their options to purchase shares at the exercise price. This can be contingent on certain conditions, such as continued employment or performance metrics.
• Expiry: Options usually have an expiry date, after which the right to purchase shares lapses.
• When properly structured and managed, option plans can be a powerful tool for aligning employee interests with those of the company and its shareholders. However, navigating the legal, tax, and regulatory landscape requires careful planning and professional guidance.
• Phantom Share Plans (or Share Appreciation Rights): These are not actual share ownership plans but rather bonus plans tied to the value of the company’s shares. Employees receive cash payments equivalent to the increase in share value over a certain period without owning shares.

With the increase in Employee Share Ownership Plans in recent times, the most important question to consider is: What is your business trying to achieve?

By implementing a plan and matching the correct legal structure, you can provide maximum benefit to not only your employees but to the business and the owners.

To learn more about Employee Share Ownership Plans (ESOP), you can attend this free ESOP webinar to see how to get your employees on board and help you accelerate your business growth. 

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Dr Craig West

Founder & Chairman | Succession Plus

Dr Craig West is a strategic accountant who has over 20 years of experience advising business owners.

With a background as an accountant in practice and two master’s degrees, Craig formed a strong view that the majority of business owners (and often their advisers) were unprepared and unaware of the steps required to prepare for exit. He then designed and documented a unique 21-Step Business Succession and Exit Planning process to assist owners and their advisers in navigating this process.

Craig now acts as a strategic business and financial mentor for mid-market business owners. Craig has written four critically acclaimed books educating business owners on employee incentives, succession planning, asset protection, and exit strategies. Additionally, he has completed doctoral research on Employee Share Ownership Plans (ESOPs) for succession.

Craig is a Member of the Forbes Business Council where he leverages his extensive experience to contribute valuable insights on helping business leaders navigate the complexities of growing and exiting their businesses.

In April 2024, the Exit Planning Institute admitted Craig to the International Exit Planning Circle of Excellence.