What is employee share ownership/ESOP?
Employee share ownership or employee equity ownership is a where a company gives its employees shares in the company in which they work. This can be part ownership or full ownership, where the employees effectively own the company. This can be used to assist with employee engagement, employee involvement, motivation and retention. SMEs are also using this vehicle for succession planning where the founder of the business is looking to retire.
Employee can acquire shares as part of an ESOP, the shares are either purchased or granted free of charge, gifted to employees. Purchase of shares can be financed by a loan, or by deductions from employee salary (salary sacrifice), bonuses and profit shares. Some companies use rights or options at this employee level.
In simple terms, an ESOP provides a way for employees to become part-owners or full owners of their employer’s business.
How are they different from other forms of remuneration?
The key difference between employee ownership or ESOPs and other forms of remuneration is that they transform the relationship with an employee into being a part owner in the business. This will often change the mindset and thinking of the individual and the way that they approach the work place, instead of me the employee starts to think about us. Research has shown that it can increase productivity by up to 5% when combined with employee engagement and involvement.
Why would an employer implement an ESOP?
There are a number of reasons why a company would implement an ESOP:
– to meet competitive advantage and become an employer of choice, 90% of listed companies have some form of employee ownership. Regardless of whether you are an SME or a listed company it is likely that that you will be competing with listed peers. This driver operates at all employee levels given that most listed companies have at least some form of employee share plan;
– to reward, incentivise and motivate staff;
– to improve morale;
– to create trust, build an community and create a better work environment;
– to increase productivity and profitability. The productivity and profitability effects of ESOPs are most evident in those businesses where the majority of employees participate in an ESOP, have some form of employee engagement or involvement and where the employees own a sizeable part of the company. It is commons sense. If employees feel that they “belong” to the company in which they work, they will work better and the company’s performance will improve;
– retirement planning or succession planning, if a founder is looking to retire and has no obvious buyer or successor for the business he or she may look to sell the business to the employees. Part of the driver for ESOPs being used in this way is that the philosophy and structure of the business is likely to remain intact after succession has taken place because existing employee become the owners.
What are the common ESOPs used in Australia for plans for all employees?
Employee share ownership or ESOPs can take a number of forms in Australia. The most common are at the employee level are:
– $1,000 Tax Exempt Plan. This is where every employee is able to buy or get free shares in their employing company up to $1,000 per financial year. The employee must hold the shares for 3 years or until they leave the company, whatever happens sooner. Regardless of whether they leave or stay they will not lose the shares in the ESOP. The $1,000 is tax exempt provided the employee’s total taxable income is less than $180,000 per annum. This plan is covered by Division 83A, in the Income Tax Assessment Act 1997.
– $5,000 Salary/Bonus Sacrifice Plan. This is where an employee salary sacrifices some of their own salary/bonus to acquire shares in the company they work for. The amount is up to $5,000 per financial year and allows the employee to defer tax for up to 7 years (depending on how long the shares are restricted for). Some companies also offer their employees company or matching shares, so for every share that the employee buys the company provides a free share. This plan is covered by Division 83A, in the Income Tax Assessment Act 1997;
– Loan Plans. This is where the company provides a loan to the employee to purchase shares in the company. The loan is usually interest free and non recourse or limited recourse (the only security for the loan is the shares, so if the share price falls only the shares are lost). This plan is outside the Income Tax Assessment Act 1997, Division 83A. This is a very common vehicle for unlisted companies.
Why do workers get into ESOPs?
In a recent Melbourne University study a group of employees were asked certain questions and below is what employees ranked as the most important elements of an ESOP:
- Financial payoff (68%)
- Fair treatment (67%)
- A sense of community (59%)
- Employee influence on management of the Company (42%)
- Individual influence on decisions affecting daily work (38%)
So ESOPs are used for:
- Savings vehicle. A major attraction ESOPs have for employees is that they accumulate savings and acquire and hold shares. Most plans have a long term focus 3 – 7 years.
- Participation. Employee ownership gives employees a sense of community, allows employee engagement and involvement, as part owners they feel part of the decision making process.
- Succession planning. When the owner (or owners) want to retire (or change their business direction) and need to sell. In these instances an ESOP can be an effective employee buy-out instrument.