Employee Share Schemes (ESS) allow you to purchase shares in the company you work for generally at a discount to the market price. The scheme may also allow you to buy the shares with pre-tax income via a salary sacrifice arrangement. This means you may be able to buy more shares than if you were using post-tax income.
Each scheme will have particular terms and conditions that define vesting periods, purchase and sale windows and tax implications.
Each share purchased includes voting and dividend rights. Depending on the company strategy / maturity you may start to enjoy a dividend stream after purchasing the shares. Generally, start-ups are less likely to pay dividends as any profits may be retained and invested to grow the company. While more mature companies with fewer growth opportunities may return profits to shareholders via dividends, buybacks etc.
ESOP: Employee Share Option Plan
Similar in some ways to an ESS but the option provides you the right (but not the obligation) to purchase the share for a pre-determined (strike) price at a future date.
Options don’t come with voting or dividend rights and generally are not tradeable, so they can’t be liquidated prior to the exercise date if you need cash.
Why am I being offered them?
Companies may choose to structure employee remuneration to include these types of schemes to better align the interest of employee with the company. The argument is that by providing exposure to the potential upside in the company via ownership (or potential ownership) the employee is more engaged and incentivised to perform well.
For the company, the argument is that it is a way of attracting and retaining employees and reducing the amount of cash remuneration means cash can be used to invest in the growth of the company.
These types of schemes have become ubiquitous in the tech industry with some lucky participants enjoying a big payday when companies go public or are bought out by bigger players.
What’s in it for me?
Employee share schemes may offer the opportunity to buy discounted shares with pre-tax income. If you feel confident the share price is likely to appreciate in value over time, then participating in the scheme may be an attractive opportunity.
The T&Cs for each scheme can be unique so you need to investigate the details of the vesting periods, purchase and sale windows and the tax implications.
Similarly, being granted share options to buy at a lower than market price in future provides potential upside if you are lucky to be working for a fast-growing company.
What’s not to like?
In a word, ‘tax’! Paying tax isn’t a bad thing because it means you are making money but receiving some of your remuneration in the form of shares or options can make life a bit complicated.
If the ESS is a ‘taxed-upfront’ scheme the discount to the market value is treated as income and hits your tax return. This means you have to find the cash to pay the tax bill.
If you spend most or all of the ‘cash’ component of your remuneration this may necessitate selling some of your shares to raise cash. This then generates another question about CGT when selling which further complicates things.
This is where good advice from your tax accountant can come in very handy as you may be able to identify earlier parcels of shares to sell that may offer a better tax outcome.
What if I work for a US listed company?
Participating in an ESS or ESOP with a US company may also introduce currency risk to the decision about selling to meet tax obligations.
A stronger AU$ relative to the US$ makes us feel good if we are planning a US holiday but if you are selling US$ shares to bring the money back to AU$ then this is less than ideal.
Timing currency movements is like nailing jelly to the ceiling so setting in place a regular strategy to sell parcels may be akin to a dollar cost averaging strategy to smooth out the currency risk rather than try and time it right every time you need cash for a tax bill.
Fly me to the moon!
We have all heard the stories about Afterpay and ‘unicorn’ companies where staff have become very wealthy thanks to participation in an ESS or ESOP. However, for every success there are many failures.
For a start-up the value of your shares or options could disappear in a puff of smoke if the company doesn’t make it or the fabled buyout / IPO never happens.
If you work for a mature listed company with lower growth prospects you will also need to accept the ups and downs of publicly traded shares whilst hopefully enjoying your share of the profits generated by the company in form of dividends, buybacks etc.
If you participate in an ESOP the value of your options may be zero if the share price tanks and is lower than the option strike price at expiry. And if they are not tradeable you don’t have the strategy to sell parcels over time to manage this risk.
Risk management
An ESS or ESOP may effectively align the interests of staff and the company. However, for the staff member it does in a sense double down the risk because if things don’t work out you could lose your job and a significant chunk of your wealth.
Participating in an ESS offers the potentially attractive opportunity to buy shares in the company at a discount. Leaving aside the tax implications, it may be a prudent to consider managing the risk of building a large exposure to a single company. Strategies available may include using available windows to sell parcels and reallocate cash proceeds to other investments, debt reduction or use it to pay school fees for example.
Unfortunately, participation in an ESOP may not offer the same flexibility to manage risk over time. The potential upside may be significant and if you are comfortable with the risk that the value of the options may be negligible at expiry to participate in the potential upside then receiving some of your remuneration in the form of options may be attractive.
In general, we would prefer to earn more than less (all else being equal). Working for a company that offers an ESS or ESOP may theoretically mean earning more than you could otherwise earn with an all-cash remuneration package.
This article has highlighted some of the important things to be aware of when considering where you may want to work. Some of us may have a bias to potential gains which may make working for an employer offering an ESS or ESOP very attractive.
But if you are lucky enough to be in a position to weigh up different job / career opportunities then how your remuneration is structured and if the structure suits your attitudes to risk may be something to add to the consideration of company culture, the role description etc. when making a decision about a new job.
