Employee Share Ownership Plans (ESOP) – Rewarding Your Employees Differently

Sean says that it’s important to think about what stage your business is at when considering offering equity as a reward. Remember that your company will go through a life cycle of funding for which you’ll likely have to offer equity. Owners need to consider how much they’re willing to give away. 

Equity rewards are a good option to consider early in the business, in the first 12 to 18 months, when you may not have the funds to offer high salaries. This can help attract and reward early staff to take a risk working for a Startup. It’s also a good alternative to profit-sharing since your company may not make a profit in its early days.  

You need to consider the cost of putting a plan like this into place. Remember that the early stages of a business can be an expensive time. However, as your company grows, so too do the tax implications. The later you leave it the harder it is to make offering shares tax efficient for employees. 

The structure of these schemes usually means that employees who leave the scheme before its end date of 3 to 4 years won’t continue to benefit. This is because having ex-employees own shares of your business lowers the amount of control you have. Similarly, when a company is being sold, 100% of the shareholders and option holders must agree. Having shareholders who are no longer involved in the business can complicate the process.  

One option to prevent these kinds of complications is to agree on a plan for employees leaving the company early. For example, if an employee left the company two years into the scheme, their shares would be held by the company on their behalf. They would get economic benefits going forward but wouldn’t have a vote in how the company is run. Another option is to have a probation period for new employees before offering equity rewards. 

You should aim to reward all your staff for their performance but you want to focus on key employees who will drive the business forward. Equity allows you to reward everyone in the company, with some key employees getting greater benefits than others. 

You might also choose to reward external parties to your business, such as consultants. Shares can be a good reward option for people who aren’t on your regular payroll (check out our guide to payroll in Ireland for more information). 

If you have an international business, you’ll still want to reward all employees. However, you should be aware of the impact of the tax residency of your employees. For example, the tax treatments for share options in the US will be different than in Ireland. You need to question whether share options will benefit an employee, considering their tax responsibilities.  

One option for employees overseas is to pay the amount they would benefit from having shares as a bonus, without giving them the shares. However, Sean recommends implementing a share scheme for your Irish employees to start, for simplicity. 

The decision on how many shares to allocate to an ESOP depends on how much founders are willing to give away. You’ll need to consider that third-party investors can dilute your company by around 20% over its lifetime. Employee Equity schemes will dilute your control further. 

However, remember that investors will want your company to have the best employees (check out our post on what investors look for as well). Many will insist that you have a “pool” of shares set aside to reward employees before they invest. However, they won’t want this pool to dilute their shares. For example, an investor may offer to buy 20% equity of your business, on the condition that you have a 10% pool set aside to reward employees. This means you will have to cede 30% of your business for the investment. 

Wallace Corporate Counsel suggests a pool size of 8-10% for non-tech companies and 12-15% for tech companies. Remember that this is a 3-to-4-year process so you’ll need to budget the number of shares you give away. Consider the need to hire key employees, such as a CFO or CEO. You might need to offer these kinds of employees 2-5% in shares each, which will have a huge impact.  

There are several structuring issues that need to be considered when setting up an ESOP.

For example: 

• If you have a holding company AND a trading company, the equity should be offered at the holding level. 
• Consider whether you want to reward employees with shares or share options. Remember, if you give employees shares, they are immediately shareholders in the business. On the other hand, share options give employees the opportunity to buy shares at a favourable price in the future. 

• If an employee gets €10,000 worth of shares, it is considered part of their compensation package and they will pay tax on it. If they receive the same amount in share options, they won’t have to pay tax. 
• However, when a company is sold, shares sold will incur Capital Gains Tax (CGT) at 33%, while options exercised at the point of sale can incur Income Tax at up to 52%. Talk to your accountant or advisor for more advice. 
• The stage your business is at will impact which option you choose. Shares are a better option early on, while share options may be better at a later stage when your business valuation and tax implications are higher. 
• Consider the impact ESOPs will have on your control of the business. You might consider setting up a nominee structure, which holds shares on behalf of employees. Alternatively, you can create a class of non-voting shares to give employees. In both cases, they will benefit economically but have no say in how the company is run. 

This is a basic structure, which acts as a common set of rules for all employees. It lays out how options work; how are they to be exercised and how they lapse when employees leave the company or pass away. It describes what will happen if the company is sold or restructured or becomes insolvent and various other scenarios that may occur. 

This is usually a straightforward plan for all employees. The options offered usually have to be exercised within a defined period (typically less than 7 years). For plans longer than this, options will incur Income Tax at the start. This would mean employees would have to pay tax before they get value, which should always be avoided.  

This is useful when a company has grown in value but needs to offer shares to hire a key employee. The company can put restrictions on the share options they offer.

For example, you might not be able to sell restricted shares for a “hold” period. These restrictions depress the value of the shares so employees will pay less for them. Then, when the shares are sold, they will be taxed using Capital Gains Tax rather than Income Tax.

This is another useful plan for companies that have grown in value but need to hire key employees. Companies can create a class of shares that have little or no value until the business reaches a certain goal. For example, you can offer your employees shares that aren’t worth anything until revenue reaches €5 million. This might be a good option to offer late joiners to the business. They will only pay a small amount for the shares but they will be motivated to participate in growth.  

With this kind of plan, you must re-evaluate the business every time you issue shares, for example annually. It’s suggested that you talk to an accountant or auditor the first time to get an external valuation. Subsequently, you should choose a metric and apply it every time you re-evaluate. For example, your valuation could be calculated as 7 or 8 times your revenue for the year. 

How shares and options are taxed is a very important consideration for employees being rewarded this way.  

Typically, for option plans, no Income Tax is paid when they are granted. However, it is paid when the options are exercised, on the difference between the exercise price and market value.  

KEEP plans are different in that they allow participants to be taxed using Capital Gains Tax instead of Income Tax. 

In a Restricted Share Plan, participants qualify for a lower Income tax liability because of the restrictions on the shares. This tax relief does not apply if the restrictions aren’t adhered to, for example, if they are sold before the end of the hold period. On exit of the plan, shares will be taxed using Capital Gains tax. 

Finally, for Growth Share Plans, there is no initial Income tax liability and shares are taxed using Capital Gains tax on exit. 

The amount of documentation you will need depends on the type of plan you choose. However, in most cases, you’ll have to adjust the company constitution to create different share classes and detail how shares are to be issued and what happens when they’re sold.

Costs for implementing share plans vary depending on the type of plan. However, Wallace Corporate Counsel suggests budgeting €2500 to €3000 for the implementation.