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Employee Share Ownership Plans

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In earlier editions of MST News we gave you regular updates on amendments to the rules governing the taxation of Employee Share Ownership Plans (ESOPs).

While these articles explained the development of the laws relating to ESOPs (especially in relation to the taxation of ESOPs), we thought it may be helpful to provide a general overview of ESOPs and a simple, practical outline of how they operate.

Purpose of ESOPs

ESOPs allow employers to offer their employees equity in the companies they work for.

While ESOPs are implemented for a range of reasons, often they are used to:

  • Increase the productivity and success of the business by motivating employees
  • Increase employees’ interest in the growth of the business
  • Reward employees
  • Assist with staff retention
  • Improve relations between employers and employees

ESOPs are primarily used in Australia by employers looking to incentivise their employees but can also be used as part of a retirement or succession strategy.

Different ESOP structures

There are a number of alternative ESOP structures (and other types of arrangements) employers can adopt.  The alternatives range greatly in terms of complexity and cost to implement.  Examples of ways to achieve the above objectives include:

  • Trust structures
  • Share purchase plans
  • Option plans
  • Loan plans
  • Phantom or shadow share plans
  • Profit share arrangements
  • Bonus schemes

The type of structure an employer should adopt will depend on the particular circumstances and objectives of the employer.  There are a number of matters an employer needs to consider, including the following:

  • How many employees will be offered the opportunity to participate
  • Whether the shares will be gifted to the employee or whether the employee must pay for them
  • If the employee will pay for the shares, when payment needs to be made and whether the price will be fixed or based on the value of the company at a future time
  • Whether the employee must satisfy certain conditions before being entitled to the shares (for example, whether the employee must be employed for a certain period of time and meet KPIs)
  • Whether the employee will forfeit the shares or can be forced to sell the shares in certain situations (for example, if the employee’s employment ceases)
  • Especially in relation to private companies, the rights of the employee as a shareholder, including:
    • the ability to appoint directors
    • restrictions on the disposal of shares
    • whether the employee’s consent is required to implement key decisions (for example, funding or entering into key contracts)

Trust Structures

A trust structure is commonly used by employers, although they tend to be used by larger employers as they more complicated than other alternatives.  Below is a brief overview of the steps required for a business to implement and operate an ESOP based on a trust structure:

1.  Establishing the trust

The employer must set up an ESOP trust to hold the shares in the employer’s company on the employees’ behalf.

2.  Making the offer

The employer provides eligible employees with the opportunity to participate in the ESOP.  This offer should be in writing, provided to each eligible employee, and provide sufficient detail regarding the key terms and conditions of the ESOP including:

  • The number of shares to be offered to the employee
  • The terms of issue of these shares (such as whether the employee will need to pay for the shares, and if so the terms of payment including the issue price of each share)
  • The conditions the employee must satisfy for the shares to “vest” (for example, meeting a  minimum employment term and KPIs)
  • The date (assuming the relevant conditions have been met) the shares vest.

3.  Issuing shares

The required number of shares are issued to the trustee of the ESOP trust.  The trustee then sets up an account for each participating employee and the number of shares that each participating employee has subscribed for is allocated to that employee’s account.

While the shares may be gifted to the employees (to be initially held by the ESOP trust) for no consideration, usually some payment is made.  Commonly, participating employees’ bonus or their salary (or a portion of either of these amounts) is retained by the employer as consideration for the shares which are issued.  Alternatively, the employees may make the required payments to the employee themselves.

4.  Dealing with the shares

Once the shares have been issued, they are held by the trustee of the ESOP and cannot be sold or transferred by the employee until the “conditions” attached to them have been satisfied.

Once the employee has satisfied the conditions attached to the shares, the shares “vest” and the employee can request the trustee of the ESOP to transfer the shares to them in the their individual capacity or to a nominee company.  Once the shares have been transferred to the employee they are free to deal with them in any way they wish (subject of course to the terms of issue of the shares) and may be entitled to dividends or profit distributions or to transfer the shares to a third party.

ESOPs are a great tool to incentivise employees, are useful in retirement or succession planning and help ensure that the interests of employees and employers are aligned.

Below are links to MST’s earlier articles regarding Employee Share Ownership Plans:

Employee Share Ownership Plan Saga Continues (Aug 19th, 2009)

Employee Share Ownership Plans – Urgent Update (Jul 22nd, 2009)

Employee Share Ownership Plans Under Attack (Jun 10th, 2009)

Please contact one of our Corporate Advisory lawyers if you would like to discuss the benefits of an ESOP further.

Authors:  Savvas Apostolou and Sam Kings