Australia: Employee share schemes (ESS)

Last Updated: 16 May 2019
Article by Eric Kwan and Sam Harmer

Following the fallout from the Banking Royal Commission, we saw the inextricable link between short term performance pay and toxic corporate culture. In an effort to correct these corporate governance issues, Commissioner Ken Hayne called for companies to realign their executive remuneration with risk management efforts and long-term financial sustainability. A commonly overlooked, but powerful mechanism that can help companies achieve these Hayne recommendations is an employee share scheme (ESS).

An ESS is a tool employers use to remunerate employees and align employee interests with their own. A well devised ESS can also:

  1. motivate key employees to build sustainable long-term value by giving them a vested interest in the employer's ultimate success, rather than fulfilling short-term performance goals;
  2. retain key employees and the corporate knowledge they have by providing a cash-free source of remuneration without impacting on working capital or cash flow position;
  3. be a core component when trying to attract new and important talent to the business, even though the company may not be able to match offers from larger competitors;
  4. be a tax efficient means of remuneration through the potential application of tax concessions; and
  5. assist with succession planning by allowing owners to decide how and when they leave the company.

What's the downside?

Whilst most of these issues can be managed through careful thought and planning, potential issues include:

  1. Potential Dilution and loss of control: Under an ESS, you give away part of the business. This may include a right to future dividends, voting rights or a portion of the proceeds if the business is sold however, ultimately, you decide what it is you give to your employees.
  2. Administration costs: There are costs in setting up an ESS and running it. In most instances however the benefits of a well-planned and thought-out ESS will outweigh these costs in the long-run.
  3. 'Free Rider' Problem: There will at times be employees who are not interested in owning a part of the business so participation in an ESS may not particularly motivate them. In those circumstances, it is important to remind yourself that an ESS is just one of many tools for managing staff.
  4. 'Blue Sky' Potential: What is worth nothing now may become a small treasure trove down the track. Whilst this is not really a problem as the intention of any ESS is to reward an employee for their efforts, you do need to be fully aware of what your business is worth when you issue interests under an ESS.

So what's the next step?

A well thought-out ESS can be the mainstay of your remuneration policy and be key to talent coming onboard and staying with you for the long journey ahead.

As an ESS can take on many forms, and have attached many different bells and whistles, ESSs are typically custom built for the company to match its specific objectives. To get the most out of your ESS, it is important that advisors are engaged early to help you decide on what you may need and plan the course forward.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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