Every business leader wants to keep their employees engaged and incentivised to improve their company’s overall performance.
Research shows that companies with employee share plans have ‘lower employee churn, higher sales, higher value added, higher labour productivity and higher growth’ than those without.
We’ve prepared a guide below to help your business implement and start reaping the benefits of an Employee Share Option Plan (ESOP). We’ll delve into what an ESOP is, how it works, what to consider, and more. By the end, you will have a better idea of how ESOPs can benefit your company and why so many companies in Australia choose BoardRoom as their ESOP solutions provider.
What is ESOP?
An Employee Share Option Plan (ESOP) gives employees the opportunity to purchase company shares at a future date for an agreed price. ESOPs differ from Employee Share Schemes (ESS) in that they give employees the option to buy shares instead of simply enabling them to purchase those shares outright.
How Does ESOP Work?
In countries such as Australia, ESOPs can be a win-win for both employees and the companies they work for. By offering employees the option to purchase company shares, they become partial owners of the company and benefit from its success. They’re a great way to reward and compensate high-performing employees while freeing up cash for your company. An ESOP incentivises employees to become personally invested in your business’s well-being, which can lead to sustained growth and increased company performance.
The Life Cycle of an ESOP
The four main stages of the ESOP life cycle are:
- Offer: employees receive an invitation to participate in an ESOP via an offer. If they accept the ESOP offering, the business allots a fixed number of share options to them.
- Vesting: generally, once an employee has fulfilled a time-based service condition or specific performance obligations, a proportion of the allotted options will vest. Once vested, employees can exercise their right to purchase these company shares.
Exercise: to exercise these vested options, the employee must pay the total exercise cost (number of options multiplied by exercise price) to receive the shares. Once the employee has completed the purchase, the shares acquired generally allow for rights, including voting and/or dividends. If the employee doesn’t exercise their vested options before the expiry date, the options lapse. This means the employee can no longer exercise these options.
Leaver and Lapse: generally, all of an employee’s unvested and vested options will lapse if that employee leaves the company. However, this can depend on the specific rules of each company’s Employee Share Option Plan. Some companies include buy-back provisions within their ESOP rules to allow the company to repurchase share options from employees. The buy-back price may differ depending on circumstances, such as whether the employee leaves the company on good terms or not.
Key ESOP Management Considerations
ESOPs are a way for organisations to attract and retain quality staff in Australia, but these plans need to be tailored to fit each company. To effectively manage an ESOP, your company should consider its capabilities relating to plan administration. Factors here include:
- Accounting
- Compliance management
- Vesting hurdles and dates
- Transfers and exercise of options and shares
- Management of employees who join and leave the plan
- Taxation reporting
Example of an ESOP
Consider an example scenario where an employee accepts their company’s ‘ESOP 2021 Offer’ on 1 September 2021. This offer is for 900 options with an exercise price of $1 per share.
These options will vest annually across three years in equal proportions. The expiry date of the options will be 10 years from the offer date, which will be 1 September 2031.
| ESOP 2021 Offer | Vesting Dates | Options to be Vested | Unvested Options | Vested Options |
|---|---|---|---|---|
| Allotment Day | 1 Sept 2021 | 0 | 900 | 0 |
| Vesting 1 | 1 Sept 2022 | 300 | 600 | 300 |
| Vesting 2 | 1 Sept 2023 | 300 | 300 | 600 |
| Vesting 3 | 1 Sept 2024 | 300 | 0 | 900 |
- On 1 Sept 2021, 900 options are allotted, but all remain unvested, which means the employee cannot exercise any options.
- On 1 Sept 2022, 300 have vested, meaning the employee can exercise them by paying the exercise cost of $300 (300 Options x $1) to acquire 300 shares in the company.
- After 1 Sept 2031, all vested options will lapse. If the employee hasn’t exercised all options before this date, they can no longer do so, as the options have effectively expired.
- In 2026, the employee leaves the company. According to the rules of this ESOP, all vested and unvested options expire as soon as the company receives the employee’s resignation notice.
Common ESOP Configurations
The above example is just one way to configure an ESOP. Here are some other common configurations that your company may wish to consider implementing:
- Performance-based vesting conditions: including a performance matrix in the ESOP rules and stating the number of options to be vested depends upon the employee fulfilling specific work performance obligations.
- Biannual vesting: increasing the vesting frequency.
- Broad-based share option plans: an ESOP arrangement where all employees are offered the options, instead of only specific individuals.
- Retirement benefits: as an extra reward, some companies may allow retirees to continue holding on to their vested options until the expiry date. This means the options don’t lapse when the employee retires.
How well ESOPs work does not only depend on a company’s financial performance but also the design of the plan. It’s important to be aware that no single employee equity plan configuration will work for every organisation.
That’s why we have designed our Employee Share Plan services and ESOP software solution to be completely flexible. In addition, not only are our Employee Share Option Plans tailor-made to suit the needs of your organization, but they are also compliant with the laws and regulations of Australia. We can provide you with a purpose-built solution to meet your needs, increase efficiencies, and reduce costs, all while complying with current and future reporting requirements.
Need Help Implementing an Employee Share Option Plan in Australia?
Now that you have a better understanding of what an ESOP is and how it can benefit your organisation, consider speaking to our team of experts today to get started on implementing an ESOP in your company.
At BoardRoom, we use leading technologies and a panel of experts to guide you through implementing and administering your ESOP through EmployeeServe, our integrated employee equity plan software. Our systems and expertise ensure the process is seamless and worry-free.
It’s why so many of Australia’s largest employers have chosen us to implement and manage their Employee Share Option Plans.
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