There is a common misconception that employee share and option schemes (ESOPs or ESS's) are the exclusive domain of tech start-ups and large corporates. However there are a number of reasons why all companies, particularly privately owned ones, should consider them as part of their overall strategy.
1. Attract high quality staff.
High quality employees, particularly more senior ones, are coming to expect equity incentives as part of their remuneration package.
If you are competing with larger companies, equity incentives can be a critical component of your employment offering. This is precisely how start-ups are able to attract staff who otherwise may not be interested.
Unless you have a strong brand or are willing to pay above-market salaries, you may find it challenging to recruit high quality people without offering something different. This is where an employee share scheme can assist.
Keep in mind that employee share schemes can vary in their scale. Sometimes they are offered to all employees, sometimes to one or two employees, and often somewhere in between. The scale of any employee share scheme will depend on the size and nature of the company and the objectives of those implementing it.
2. Retain strong performers.
Just as important as your ability to attract high quality staff is your ability to retain them.
Employees are more likely to think twice about leaving if they stand to walk away from something valuable.
Employee share schemes can be an effective way to protect your company against the risk of key employees being poached by other firms.
3. Change the way your people think and behave.
Employees who own a meaningful stake in a business think and behave differently to those who don't.
The more material their stake, the more likely employees are to make decisions that align with the objectives of the major shareholders.
Note that what is meaningful for one person might be immaterial for another. This is why employee share schemes commonly offer different incentives to different people (or classes of people) in the same organisation.
Research also suggests that where employees are given the opportunity to participate in decision-making (in addition to share ownership), they tend to be more engaged than those who are not.
4. Create or expand opportunities to exit.
At some point, business owners will usually want to realise the value of their investment. Employee share schemes can help facilitate this in a variety of ways.
An employee share scheme can be used to create a market for the owners' shares where buyers may otherwise be hard to find.
Second, even where potential buyers may be relatively easy to find, an employee share scheme can sometimes be effective to:
- create a pool of buyers who may be interested to pay more than market value for the balance of the shares; and/or
- create competition between potential buyers, thereby increasing the likely exit price for the current owner(s).
Independently of this, companies with a strong management team (independent of the exiting owners) are usually valued more highly than those without.
5. Take advantage of potential tax efficiencies.
The availability of potential tax concessions is not a reason for implementing an employee share scheme. They should be one of your last considerations, and only after you have decided to commit for other commercial reasons.
That said, well-structured employee schemes can produce tax results that would not otherwise be available for non-equity incentives. (CGT relief is an example.)
There are numerous other reasons why companies adopt employee share schemes.
There are also numerous reasons why companies don't adopt them, such as their cost and potential complexity. Their real value is often not seen until several years after their implementation. Owners are often reluctant to give up control or allow their ownership stake to be diluted.
The process of considering a share scheme involves a careful analysis of the owners' commercial objectives, and a weighing up of the various pros and cons. If a decision is made to go ahead, the focus is then on designing a scheme that manages the risks and otherwise aligns with the owners' objectives.
If you would like to know more, and understand about the different models that are currently used in Australia, we would encourage you to read our free downloadable guide, available here.