Introducing an employee share scheme: what every company should know

Employee share schemes (ESS) can be a powerful form of remuneration. Aligning the goals of the company and employees can enhance performance and create value for shareholders, while providing a highly effective way to attract and retain high performers. What should you consider if you don’t have an ESS and are thinking about introducing one?

1.      How will the ESS create alignment with company strategy?

ESS awards need to be earned by participants. They are generally granted on a contingent basis, with performance conditions that need to be satisfied. Structuring the conditions to be met before an award “vests” or comes home, is crucial to driving company value. Considerations include:

• Is the award intended to reward short- or long-term performance?

• What are the best measures of performance: external measures such as share price relative to a peer group, internal measures such as achievement of key milestones, personal measures such as annual performance rating, or a combination of these?

• Can the conditions support ESG objectives?

• What restrictions will apply to disposal of the shares and how will they be enforced?

• What is prevalent in the market and acceptable to shareholders?

2.      What are the costs of awarding shares?

Companies will typically have a choice of issuing additional shares or purchasing shares on-market. Issuing capital will dilute the value of existing shares but does not require a cash outlay. Acquiring shares avoids dilution but has a cost attached.

It is important to understand the accounting impact and how the cost will be recognised and reported and this can differ based on how key terms are structured.

The company may be eligible to claim a tax deduction, depending on how the award is structured.

Consider how the ESS reward interacts with the total remuneration package e.g. what proportion it represents of total remuneration and whether this is aligned with market practices.

3.      What are the administrative considerations?

If setting up a new plan, factor in the costs of legal and accounting advice to ensure the correct documentation is in place and all regulatory reporting requirements are met. The Corporations Act includes requirements on disclosure, licencing, advertising, hawking and the on-sale of financial products, though certain exemptions may be available. The Australian Taxation Office (ATO) also requires various reporting requirements to be met and state payroll tax may apply. Consider:

• Shareholder approval processes;

• Documenting the essential mechanisms in a formal Plan;

• Developing offer letters and summary guides;

• Having mechanisms to address reporting to the ATO, State Revenue Office and employees;

• Financial statement reporting;

• Tracking progress against the performance conditions;

• Overseeing an employee share trust, if this is appropriate to support the plan.

4.      Will participants value them?

ESS interests can be a mystery to many employees. For those who are unfamiliar with them, being awarded an option that may or may not vest in 3 years’ time may not seem highly motivating. If they have heard bad news stories from colleagues about unexpected tax costs, or worse still, if this is something they experience from participating in the plan, this will undermine the intent and value of the plan in seeking to reward their performance. There must also be clarity on how the value will be realised when the award vests, including ongoing restrictions that may apply if the participant possesses sensitive information and for private companies, what the mechanism is to dispose of the shares.

Therefore, it’s important to address the following:

• Create great communications – summary guides with examples, written in simple English

• Provide opportunities to ask questions

• Highlight the need to seek advice

• Address tax consequences clearly to avoid surprises

5.      Is it the right form of plan?

While certain plans are prevalent in particular segments of the market e.g. performance rights for ASX 200 companies, different considerations arise depending on the company’s profile and the drivers behind the plan. Shareholders of a private company should carefully consider the mechanisms to dispose of shares, considering whether this can only be achieved via buy-back and how the shares will be valued at that time. Additional tax complexities may also arise for private companies. For this reason a phantom or cash-based plan may be preferable.

Plan types may include:

• Performance rights

• Options

• Shares

• Premium priced options

• Loan shares

• $1,000 tax exempt plan

• Salary sacrifice plan

• Phantom plan

In each case, understanding the differences in administration, tax outcomes, reporting and ongoing compliance are essential to selecting the right plan and delivering it successfully.

Disclaimer

The advice and information contained in this summary are of a general nature and should not be relied upon as professional advice, nor an exhaustive outline of considerations. It is recommended that you seek appropriate professional advice tailored to your organisation’s specific circumstances before making any decisions or taking any actions based on the content herein.