There are different types of Employee Share Ownership Plans that will suit different businesses. The main ones include:
1. Call Options
Call options create a contract between the company and employee, which obliges the company to issue new shares to the employee in the future at a specific price specified by the contract.
This type of contract can benefit employees in that it allows them to participate in the upside of share price increases. Call options are also common where the future of the company is still hard to predict.
It benefits the company as it aligns the employees to the company objectives which can increase the share price, provides remuneration that doesn't require cash and provides some risk mitigation as shares are unlikely to be issued when there has been no share price appreciation.
To create the ESOP, the company will sign an Employee Share Option Deed. This will set out the terms of the scheme, who may participate and how the scheme will be operated. Participants will acquire their options by signing an invitation letter sent by the company.
Share options are traditionally earned through longevity in the company and/or performance milestones. Share options will normally defer the tax payable by the employee until the point the options convert to shares. Eventual tax implications for the employee can be aligned with the employee's opportunity to sell the shares when it will be easier to find any tax payment.
Early-stage investors will often request that an ESOP is implemented prior to their investment, as they recognise their potential value for the company. More mature companies can also benefit from an ESOP when they are heading toward a sale or liquidity event.
2. Loan to Purchase
A loan to purchase scheme will typically be used to immediately ‘sell’ ownership of shares to employees. Often favoured by more established companies, a trust entity could also be established to hold shares for employees in the parent company.
Typically businesses will either offer a low or no interest loan (or a bonus payment) to fund the purchase of the shares. Loans will often not require repayment until such time as an eventual liquidity event in the company.
3. Phantom or Bonus Share Schemes
A phantom share scheme will provide participants with a contractual right to a monetary amount on certain events occurring or certain KPIs being achieved.
Phantom share schemes create some of the benefits of formal share ownership without requiring the physical transfer of shares or options. Often favoured in businesses with a strong profit share focus, Phantom schemes allocate 'shares' to employees who will get a cash bonus based on their 'ownership' when dividends are calculated and/or a liquidity event occurs.
4. Management Buy-Outs
Whilst not always classed as an ESOP, management (or managed) buy-outs can be used as another way to create ownership mentality within your key staff, particularly in more long standing or profit driven companies. A management buy-out scheme creates transactions where a company’s management team or senior staff purchase the assets and operations of the business they manage. However these transactions may not always happen on one date, hence why management buy-outs can be classed as ESOPs.
A management buy-out is appealing to professional managers and senior employees because of the greater potential rewards and control from being owners of the business rather than employees. For the original owners, a management buy out can also create a way to exit their business over a period of time in a controlled way.
Whilst the Orchestra team is always available to discuss the right method of ESOP for your business we also encourage conversations with your lawyers, accountants and other suitable professional service providers.
Contact us if you would like to learn more about ESOPs.