A beginner's guide to employee share schemes


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If you are an employee in demand, you could be offered shares or options by a company as a motivation to join or an incentive to stick around.

Employee share and option schemes have been growing in popularity over the past couple of years, particularly in the technology and start-up sectors. They are being offered by both listed and unlisted companies.

"Working from home and burnout from the pandemic has resulted in all employers considering their value propitiation to employees," says Peter Bardos, HLB Mann Judd's Sydney tax director.

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There is a war for talented employees, particularly in light of "the great resignation", which in the US has seen 48 million people leave their jobs and in Australia is becoming evident, too.

Two in five Australian workers (43%) are unhappy with their work and plan to search for a new job in 2022, according to a survey by Elmo Software.

It found that a third of workers say they plan to quit their current job as soon as they secure a new role, with 19% intending to quit without another job lined up.

Employers are enticing employees with a whole host of incentives. Surveys show that employees value more flexibility, the option to work remotely more often, access to extra annual leave as well as increased wages and promotion.

Offering shares or options in the company at a discount to the sharemarket trading price can accelerate your wealth if the share price rises.

In some instances - usually at the executive level - shares and options are gifted as a golden handshake.

Changes to schemes allowing employees to build more equity in businesses are making employee share plans more compelling.

Who qualifies for an employee share plan?

Share and option schemes are marketed to employees as a way to help them take part in the company's success.

"Employee share and option schemes can be an effective form of motivation, especially in high-growth companies or executives of listed companies," says Bardos. "An ESS is usually linked to both employee-level and employer-level targets, and the motivation is for the employee to work toward these targets to enjoy the financial benefit."

The schemes can help accelerate your wealth. If the company does well - and many do - then you can hit the jackpot.

"They have a tonne of opportunities and if you don't take advantage of them, you leave the money on the table," says Ben Nash, founder and financial planner at Pivot Wealth. "But sometimes employee share plans fail."

Bardos says employee share schemes shouldn't be considered a guaranteed acceleration of wealth. "However, they certainly have the potential in the right circumstances."

You need to understand the offering, the opportunities and the risks before you sign up. To get the most out of the scheme, you need to know the tax arrangements as well.

"Employees should understand how they are able to extract the value of the ESS," says Bardos, who recommends getting advice.

"This is an investment by the employee, especially once cash has been paid either to exercise an option or pay the tax. I have seen some instances of employees receiving shares and not selling the shares, paying tax on their value and then the shares being worth less than the tax paid."

Schemes come in a variety of forms, such as shares or options.

"However, all effectively are designed for the employee to enjoy in the growth of the employing company," says Bardos.

Nash says there are three main sorts of schemes: employee share purchase plans (ESPP), employee share option plans (ESOP) and restricted stock unit plan (RSUP).

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Pros and cons of employee share plans

You need to weigh up the pros and cons of the deal.

If you are buying shares, they are typically at a discount to the market trading price. Nash says 10% is typical.

"You are offered a bit of free money," he says. "Often the best strategy is to figure out a way to participate at the maximum amount so you can maximise the free money."

The first step is to let your company know you want to participate.

"Then you have a period of time to purchase the shares, meaning you need to come up with the money."

Nash says companies often give employees three or six months to pay for the shares. To avoid a cashflow issue, you need to plan ahead to make sure you have the money needed at the due date.

"You may be required to hold the shares for a certain period of time before you are allowed to sell," says Bardos. "Restrictions on sale of the options or shares are common in addition to performance targets.

"Leaver provisions are also common - for example, good and bad leaver provisions that may define whether the employee retains their ESS after their employment ceases. Once the shares become available, you can choose to sell or keep them."

There is tax to pay on the free amount, says Nash. "This is considered a benefit and assessable in the eyes of the tax office. If you got a $1000 discount on your shares, the ATO looks at that and says you have got a $1000 cash bonus."

If you don't sell the shares, you still have to pay tax on that bonus. "People get their tax bills and they get a rude shock because they haven't factored this in."

From July 1 this year, there are changes to the taxing point of employee shares. You no longer have to pay tax on shares issued under the scheme when you exit the company. Instead, shares and options can be disposed of without a penalty in a 15-year deferral period.

Bardos points out this tax change is only applicable to new share schemes granted after July 1, 2022.

"This will likely be administratively challenging for employers and confusing for employees that have existing ESSs."

Downsides of work share plans

With restricted stock unit plans, you are granted shares that are vested after a certain amount of time with the company. They are common in technology companies that can't compete with the salary and wages offered by larger and more established businesses.

In many instances, employees are granted more shares each year and then have to wait three years to vest.

"They essentially become like golden handcuffs," says Nash.

He says the capital gains tax applies straightaway.

If you are in one of these schemes, you are still subject to the old rules where you have to pay tax when you leave the company.

"If you don't love your job and haven't planned the tax, you can't walk away from your job," says Nash.

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Bardos says there are risks for both unlisted and listed company share schemes. However, it may be more difficult to extract the value from an unlisted company scheme.

"Understanding how this is available is key when assessing the risks. Shares and options in unlisted companies will often be tied to a public offering or takeover events but can be funded by the employer through a buyback with a differing tax outcome," he says.

You can borrow money to buy shares or options, says Bardos. "Some financial institutions have special arrangements such as funding an option and arranging a sale or ceiling- and floor-type loans."

Employee share plans and tax

While interest paid to fund an ESS is likely tax deductible, subject to some rules around ceiling- and floor-type loans, interest on money lent to fund a tax bill is likely not deductible, says Bardos.

It is important for employees to understand that if they are to hold shares in a listed company there is market risk. If the sharemarket falls in response to an event similar to the GFC, it is likely the price of their shares will go down, too. These sorts of events are impossible to predict.

The regulator, ASIC, recommends that before you sign up you need to check on how well the company is performing and whether the shares are likely to increase in value. It points out that each share scheme is different, so look at the terms and conditions of the offer.

In particular check:
• When you can buy or sell your shares.
• If you will receive dividend payments.
• What happens to your shares if you leave the company?
• Check with the ATO website about the tax benefits of employee share schemes, particularly in light of the new changes

Questions to ask your employer

ASIC says always ask your company questions for more information if there is anything that you're unsure about.

Everyone should consider their personal circumstances and financial goals, says ASIC.

"Can you afford to buy shares at this point?"

Or do you have other financial options, such as paying off your mortgage faster and contributing extra to super?

It is always worthwhile diversifying and spreading your investment risk. ASIC recommends considering the worst-case scenarios, such as the shares falling in value or the company going out of business.

You may be taking on too much exposure to one company. Being gifted shares in a start-up company is one thing, but buying shares in a start-up, even at a discount, can compound your risk. Failures of long-established companies are less likely but do occur.

Some surveys of executives indicate that many dislike the complex rules around share and option schemes. One executive told a PwC remuneration survey: "I don't assign any value to my share allocations. I consider them in the same way as a company lottery ticket."

A concerning issue is the metrics used to set the incentives to qualify for executive shares and options. Often, they are purely financial hurdles. In response to the Hayne financial services royal commission, APRA said it wanted banks and financial groups to include other metrics for their incentive remuneration, but it had found this to be a complex area that is hard to define and enforce.

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What to consider before you sign

• You benefit financially if the company performs well.
• It could motivate you to stay longer with the company.
• You may be able to buy shares at a discount on the current market price.
• You may not have to pay a brokerage fee when you buy or sell shares.
• You could get tax benefits, depending on the features of the share scheme and your financial situation.

• There are likely to be limitations on when you can buy or sell shares.
• If you're paying for a share package over time, you might have to pay it off before you can sell the shares.
• You may have to give back or sell your shares when you leave the company.
• Your share package could come with restrictions. For example, you may have to meet performance targets or stay with the company for a certain number of years.
• You could lose money if your shares go down in value or the company goes out of business.
Source: moneysmart.gov.au

Rules relaxed for start-ups

Unlisted start-ups are able to compete with listed ASX companies and overseas companies by offering their non-executive employees (referred to as 
non-C-suite) bigger incentives, bonuses and more equity in the business.

Start-ups will be able to offer an unlimited number of shares of unlimited value as long as the employee is not charged more than $30,000 for them, up from the previous cap of $5000. Employees can accrue unexercised options over five years, up to a maximum of $150,000.

By removing these regulatory barriers, it will be easier for a viable but cash-poor business to hire employees with ESS offers, in addition to wages.

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Susan has been a finance journalist for more than 30 years, beginning at the Australian Financial Review before moving to the Sydney Morning Herald. She edited a superannuation magazine, Superfunds, for the Association of Superannuation Funds of Australia, and writes regularly on superannuation and managed funds. She's also author of the best-selling book Women and Money.
Albert Kalaja
February 17, 2023 6.39pm

A great beginner's guide...a quick overview but to enough depth to raise other questions/issues for us to consider. Very grateful for this - informative and without the "come and talk to us because we've only told you a third of the story" type of articles written by some accountants, financial advisors and lawyers.