Articles > Startups

What is an ESOP?

September 19, 2020   Philip EvangelouRaymond Chbib

An Employee Stock Ownership Plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company. Usually formed to facilitate succession planning in a closely held company, ESOPs are a way to get employees more invested in the growth of the business. ESOPs allow employees to receive shares or options to share in the company they work for, consequently receiving financial benefits when the company performs well. 

ESOPs are particularly attractive to startups, who don’t have the financial capacity to afford top-tier salaries, but can attract top talent through engaging employees into the with ownership.

Understanding ESOPs 

ESOPs are centered on the purchasing and receiving of ordinary (ORD) shares that are typically vested overtime. Upon vesting, the employee can exercise their rights in accordance with the ESOP to purchase shares.

ESOPs can be customised based on the size of the company, number of employees and purpose of introducing the scheme. Whether the company is publicly listed or privately operates will also dictate the nature of the ESOP. In Australia, a recipient of ESOP securities cannot own more than 10% of the company in total. 

The Benefits of an ESOP

Establishing a proper ESOP in your startup will confer many benefits upon the employee as well as your company. ESOPs can strengthen employee loyalty and motivate employee engagement as your company’s workforces interest aligns with that of the shareholders and the company. This is because ESOPs incentivise the employee’s effort in growing the company’s value. In turn, lowering the supervision required for employers and improving cooperation between employees as they become more responsible for the work they do By ESOPs implicitly increasing productivity and creating a market for stock consequently enhances shareholder liquidity and increases shareholder value. 

Moreover, an effective ESOP that is rewarding can attract new skill sets to your team as well as retain talented employees as they are motivated to stay loyal due to receiving equity ownership of the company. Thus, assisting startups that do not have the capacity yet to provide competitive salaries as ESOPs compensate for lower salaries.  

ESOPs and Startups

Since 2015, the enactment of new legislation has transformed the tax treatment of ESOPs making them more attractive and usable for startups. Previously, when an individual received equity “for free” meaning receiving shares under an ESOP, the market value of that equity could be taxable when the employee received it. That “free equity” can now be taxable when the employee sells the equity given that your startup must meet a certain criteria.

Under the new laws, a startup is eligible for the tax concession if they hold the following qualifying features: 

  • The company must be an Australian tax resident;
  • The ESOP must be available to no less than 75% of employees of service for 3 or more years; 
  • Any options issued under the ESOP must have an exercise price above the current market valuation of the ESOP securities;
  • The ESOP must require that securities are held for no less than 3 years or until the holder ceases employment;
  • The company cannot be older than 10 years;
  • The company’s turnover must be less than $50M per annum in the year ESOP securities are issued, and;
  • The company must not be publicly listed.

Implementing an ESOP

Implementing an ESOP will require establishing formal rules to govern the ESOP; setting out eligibility and outlining the conditions that can be set on ESOP securities. The ESOP must be formally adopted by the company (usually via a director’s resolution). In some cases shareholder approval is also needed. 
Get in touch with our startup team if you need help with implementing an ESOP or other funding options.

About Philip Evangelou

phillipPhil is a director at OpenLegal. He has over 16 years experience working in private practice and in-house counsel in Sydney and London, giving him expertise in employment law, IP, finance, leases, dispute resolution, insurance and contracts.

About Raymond Chbib

raymond chbibRaymond is a legal intern at OpenLegal, working with our legal content team. He is currently a penultimate student at the University of Technology Sydney, studying a Juris Doctor degree with an undergraduate Bachelor of Global Studies. He is particularly interested in Intellectual Property law and the increasing internationalisation of that area of business.