Busting common myths around employee share ownership plans.
While employee share ownership plans (ESOPs) have been around in Australia for several decades, they are often misunderstood and underutilised by small businesses.
Most listed companies have them because they can be a handy vehicle for attracting, retaining and motivating top talent. ESOPs can also serve as an important mechanism for business succession. But a persistent lack of awareness around ESOPs, misunderstandings around their use and confusion around the tax and legal considerations has created a few perceived barriers for small-business owners.
Let’s examine some of the critical myths.
Myth 1: An ESOP is only for larger businesses
While many listed companies in Australia use employee equity plans to reward and retain key staff, you don’t need to be a large business to use this structure. They can work equally well for SMEs and, in fact, in 2015 the government introduced new rules to encourage the use of ESOPs in start-ups.
For example, in many smaller businesses, which are typically heavily reliant on key people, having access to a tool that can effectively attract, retain and motivate those people can directly impact overall business performance. In a tight labour market (especially for construction, civil engineering and infrastructure-related businesses), it is not enough to simply offer a pay rise to attract new staff and expect existing employees to stay.
Myth 2: My employees wouldn’t be interested
Often, employers think employees are not interested or wouldn’t want to be involved in the company’s employee share plan. Nothing could be further from the truth.
“Employee share ownership plans … are often misunderstood and underutilised by small businesses.”
Research has shown that when an ESOP provides substantial financial benefits to employees and when management is highly committed to employee ownership and maintains an extensive ESOP communications program, average company ESOP satisfaction and organisational commitment are high, and average company turnover intention is low.
A 2017 study by Computershare looked at the sentiment of employees in Australian ESOPs, finding:
- 52 per cent of plan participants said the plan reduced the chance they would leave the company either “to a great extent” or “to some extent”.
- 63 per cent of participants felt “very loyal” to the company.
- 73 per cent of plan participants agreed or strongly agreed that the company was an excellent place to work.
Myth 3: ESOPs don’t work in SMEs and can’t improve performance
As far back as 1970, researchers started publishing articles stating that small businesses with ESOPs grew between 7 per cent and 23 per cent faster than traditional SMEs. They have reduced sick days and unexplained leave, retained employees at far better rates, and have improved productivity profits. In 2003, Blasi examined 70 research studies and summarised the findings:
|Performance measure||Gain from employee ownership|
|Average employee ownership||8 per cent (after dilution)|
|Productivity||4 per cent|
|Return on equity||14 per cent|
|Return on assets||12 per cent|
|Profit margins||11 per cent|
Myth 4: ESOPs are complicated and expensive
Setting up an employee share plan requires a few important legal documents and could benefit from some expertise in terms of design and structure. This should not become a barrier. In the May 2021 budget, the federal government introduced new rules to simplify employee share schemes (ESS), particularly around the set-up of ownership plans and disclosure rules.
An ESS start-up plan can be set up in as little as three weeks and for well less than $10,000, making it a relatively cost-effective employee rewards scheme. Even the most complicated plans, which have flexible rules governing entry, exit valuation and redemption of shares, can be set up in a couple of months with a budget of approximately $30,000. Compared to the cost of recruiting new staff, this is relatively cost-effective, and once set up can be used repeatedly for various staff over an extended period.
Myth 5: The ATO doesn’t like them
When it comes to regulatory oversight and compliance, it is undoubtedly true that employee share plans were used and abused 25 years ago to create fake tax deductions by contributing to family members. This is evidently no longer the case. The ATO has multiple pages on its website explaining the rules around employee share plans and promoting the tax concessions available.
Myth 6: My employees cannot afford to buy into my business
The ESOP tax concessions provide multiple concessions to assist employees in buying shares in the business they work for. At the most straightforward end of the scale, employees can earn $1000 per annum tax-free employee equity, and they can also salary sacrifice up to $5000 per annum.
In addition, the business can make contributions based on a profit share plan or achieving a set of key performance indicators for the business to assist in funding employee buy-in.
Some employees who wish to purchase additional shares can inject cash from their own savings and several banks will lend against ESOPs.
Myth 7: ESOPs can’t maximise the price of my business
The research shows precisely the opposite. One of the most significant risks in selling any business is “vital person risk”, both around the owner and the senior employees. From a buyer’s perspective, if these people were to leave shortly after a sale, the business may have a significant problem. In addition, the buyer is coming into a business they do not know and has to take over its entire operations, existing staff, customers and suppliers. Still, existing employees know all of this, and they probably also know what they can do to improve the business going forward. An ESOP can serve as a great way to empower and motivate existing staff.
By reducing these critical risks, the underlying valuation of the business can increase. In addition, by giving the employees time to buy the business, we can help maximise value and create a win–win situation for all parties involved.
The reality is that ESOPs can represent an attractive exit planning solution for SMEs that allows baby boomers to exit their business gradually over time while also ensuring the business is set up to continue successfully after the transition.
This article first appeared in issue 34 of the Inside Small Business quarterly magazine
In the print version of this article we stated Craig’s business as Succession Plan rather than Succession Plus, we’d like to apologise for that oversight and correct it here.