Can I pay employees with shares?

Can I pay employees with shares?

It is common practise for startups to offer to pay employees with shares as a way of incentivising employees without affecting their cash flow. This can be arranged by an Employee Shares Schemes (ESS). Shares as a form of payment can be beneficial for employer and employee alike: by giving employees the opportunity to become shareholders, or part-owners, within the company, they are incentivised to fuel the startup’s growth and success. As the company becomes more successful and gains more capital, the value of the shares will increase, ultimately increasing the financial gain of employee shareholders. This article explains the ways employers can pay with shares and the effects that this has on employers and employees.

The two main ways that shares are divided amongst employees are through a share split or share consolidation:

1. Share Split

A share split does not alter the total value of the business, but lowers the price of individual shares while increasing the number of shares in total. This is helpful to attracting the attention of new and prospective investors by making the share price more affordable and more available.

For example, if you had 100 shares valued at $2 each and then reduced the cost of each share to $1, then you would result with 200 shares in total. 

2. Share consolidation

This is the reverse of a share split whereby the number of shares trading are reduced by merging shares together to make one share of greater value, proportionally. The percentage of the company that is owned will not be affected despite holding fewer shares, this is called a net neutral effect

For example, you are holding 150,000 shares. A 15:1 share consolidation means that every 15 shares that you own will be reduced to 1. After the consolidation, you will be left with 10,000 shares. You still own the same monetary value of shares. The price of an individual share has increased because 15 shares have been merged into 1. Mathematically, where you have divided the amount of shares by 15, you will multiply that value of each share by 15.

What it means for the employer

It is the responsibility of the employer to make sure that they are able to uphold shares as a form of payment depending on the profit or loss of the company and to manage any additional expenses, such as stamp duty to be paid to ASIC. The employer has to ensure that they keep an up-to-date written financial record, either through Shareholder Agreements or other documentation of who the shareholders are and how many shares they hold. Under Australian law, the employer is still required to pay their employees a minimum wage with shares-based payments as an incentive.

What it means for the employee

When the employee is paid in shares, they become a shareholder within the company. They are not necessarily a majority shareholder within the company as they are still bound by their employee agreement. They are required by the employer to fulfil their duties under this agreement. As the startup becomes more successful and becomes more profitable, the employee is entitled to an increase of value of shares that is proportional to the increase of the company’s increased income.

Pros and Cons

Pros
Cons
  • Retain employees without out-of-pocket expenses for startups that may not have adequate monetary funds yet.
  • Encourage the employee to complete their job to a higher standard than if they were to be paid solely with minimum wage.
  • Future success of the company means that shares can end up equaling large sums.
  • Employees have increased input in the decisions and processes made within the startup company.
  • The employer is able to retain as much cash as possible in the early stages of the company’s start.
  • If the startup does not become as successful as expected, the employee, who is also a shareholder, can lose both investment value and a source of income.
  • Employees are seen as business partners because they have a minority say within the company.
  • There are tax consequences, including:
  • For the employee: shares can be considered as income if they substitute a form of payment for services. They remain at the same tax value as they were when they were initially acquired.
  • For the employer: the shares cannot be included in taxable deductions, whereas cash payments could possibly be part of tax deductions. There is also a complicated legal process including completing ASIC forms declaring the shares, involving stamp duty payments.

Paying employees with shares is an incentive-based strategy rather than an alternative to paying a wage. It allows startups to gain more control over their cash-flow and encourages their employees to work towards the success of the company through their own financial gain raising proportionally.