Employee Share Ownership Plans (ESOP)

What is an Employee Share Ownership Plan (ESOP)?

• An Employee Share Ownership Plan (ESOP) allows employees to buy or earn equity in the business they work for with tax concessions. ESOPs are becoming more popular in Australia and are effective at attracting, retaining and motivating key employees by providing both income and capital gains benefits.

Are all Employee Share Ownership Plans (ESOPs) the same?

• Employee Share Ownership Plans (ESOPs) are also often referred to as Employee Share Schemes (ESS), Employee Share Plans, Employee Share Option Plans, Employee Equity Plans and Employee Ownership Plans. They all refer to the same thing – a structure for employees to own shares in the business.

How does an ESOP work?

• An ESOP is a separate legal structure (also sometimes referred to as an Employee Share Scheme or ESS) that is owned by employees and holds shares in the parent company (employer). This creates real equity ownership for employees and allows them to receive both dividends and increases in value in the business.

What does it mean to be an employee-owned business?

• Businesses which are employed-owned have the majority of their equity ownership inside an employee share plan, these businesses tend to retain employees longer and research also shows they are generally better at customer service and quality. Employee ownership means employees are financially invested in the success of the business.

How are ESOP shares allocated?

• ESOP shares are typically allocated in one of two ways:

  Equally, where all employee-owners hold equal shares, or proportionally, where employees own shares based on performance, seniority, length of service, net promoter score or other similar measures to allow those employees who contribute more to the business to own more shares.

What are the advantages of an ESOP for my employees?

• Employees benefit from an Employee Share Ownership Plan (ESOP) in three ways:

  Financial alignment with the business and its owners, access to income (dividends) and access to increases in value of the business (capital gains).

  They are also more likely to be involved in decision making.

What are the advantages of an ESOP for my business?

• The advantages of an ESOP for businesses are typically the ability to attract, retain and motivate key employees. Better employee engagement and involvement in the business and the increased financial incentive for employees to focus on business improvement in productivity, quality and profitability.

What are the advantages of an ESOP for myself, as a business owner?

• The advantages of Employee Share Ownership (ESOP) for business owners are largely focused on improved employee retention, more alignment with employee interest and increases in productivity, profitability as well as improved quality control and customer service. ESOPs can also provide a Business Succession Plan option.

What is the cost of implementing an ESOP?

• Implementation of a properly designed Employee Share Ownership plan (ESOP) should take approximately 3 months and include a business review and valuation, a design phase, an employee education seminar and briefing documents, and all the legal and technical documents required. This should cost somewhere between $15,000 – $30,000.

Do employees need to be on the board if they own shares?

• No, there is no requirement for employees to join the board if they own shares as part of an Employee Share Scheme (ESS). Most employees do not want to join the board as part of an ESOP. They want to be more involved, however, can often provide ideas without being on the board.

Will implementing an employee share plan mean I need to hand over control of my business?

• No. ESOPs are not designed to transfer control (until you are ready), they are designed to transition equity to your employees to better align your interests with theirs. In most cases we use a corporate trustee for the ESOP and the directors of the corporate trustee (which manages the ESOP) are the same as the main trading entity

Do my employees expect to pay to join an ESOP?

• In most cases we can design the Plan so the employees can contribute, but we normally recommend this is not compulsory – otherwise, you might preclude good employees who simply can’t afford to write out a cheque to participate.

Who pays for the admin costs of administering the ESOP?

• The PPT pays all costs to administer the ESOP after set-up, which is normally paid by the employer/trading entity. Admin is done centrally by Succession Plus. Whilst the admin is not rocket science, it is very important it is done correctly. We have had one client who suffered a payroll tax audit because the admin was managed by their accountant incorrectly. The typical ESOP costs about $5,000 p.a. to run including bank, admin and accounting fees. It needs to lodge a tax return. Our admin fee includes an annual valuation, which is also required by law.

How do I account for the contributions - expense vs capital?

• The contribution to the PPT are a deductible expense to the company (under 8-1) as they are directly related to employees and should be accounted for separately in the P & L as “ESOP contribution.”

How does this affect the normal laws regarding employment/HR?

• The introduction of an ESOP does not change the employment relationship and all of the normal HR laws apply to employees who are members of an ESOP.

Are employees equal or different in ownership levels?

• Employees can be equal, and we have several clients who have done exactly that. More commonly, employees are allocated different amounts of equity based on salary (seniority), years of service and a performance score or some combination of these factors. It should not be discretionary.

How much equity do I need to sell-down?

• There are no hard and fast rules (and no limits imposed by the taxation law governing ESOPs). We have implemented plans with as little as 10% of shares held by the ESOP and somewhere the ESOP is gradually buying the whole business (100%).

  The amount you sell needs to be enough to be of value to employees and provide a reasonable stake in the business.

When I sell an ESOP, do I pay Capital Gains Tax?

• Yes. Your sale of shares is a taxable event for CGT, but you will still be eligible for all of the Small Business CGT concessions in the same way as if you sold the business externally.

How do buyers view a business with an ESOP?

• In most cases, this is a strong advantage. In many businesses, the key risk from a buyer’s point of view is the risk of employees leaving immediately after a sale. Whilst the ESOP cannot stop this, it can certainly reduce the risk by locking employees in with an equity stake. Many plans which are introduced in the lead up to sale include a stay bonus – an extra contribution made to the ESOP if, for example, employees stay for 24 months after the sale. In some cases, the buyer will have an ESOP already and simply roll your employees into their plan, many will just continue the existing plan, while in some cases, the buyer may choose to pay out the plan.

What happens to an ESOP if the company makes a loss?

• In the year that the company makes a loss, there are 3 implications – firstly, no contribution will be made, and no further units will be issued in that year, secondly, no dividends are likely to be paid or at least dividends will be reduced, and finally, the valuation of the business (and the ESOP) will decrease.

Can we loan funds to speed up the ESOP?

• Yes, this then makes the ESOP a leveraged ESOP, a very popular vehicle in the US. The employer (or founder) could lend money to the PPT to accelerate the purchase. A commercial loan agreement would be needed, interest could be charged, and security taken over the shares purchased using the loan funds. In addition, priority over dividends so that they are used to repay the debt before being distributed to unitholders.