What is an employee share scheme and which type is suitable for a startup?

STEPHEN ANNICCHIARICO

TECHNOLOGY & IP LAWYER

An employee share scheme (ESS) provides:

  • selected employees (Participants) of a startup company (Company) with:
    • the opportunity to participate in the success of the Company; and
    • access to long-term incentives to ensure wealth is created in the Company for the benefit of all shareholders and other stakeholders.
  • employers with:
    • increased employee loyalty;
    • incentives for employees to perform; and
    • improved organisation-wide culture.

While there are various types of ESSs out there, there is no specific “one-size-fits-all” scheme. Accordingly, I will discuss an example of an ESS that I have recommended to many of my startup clients.

ESS Example

The following example of an ESS involves the setting up of a share plan (Plan), to be facilitated through a trust and trustee company:

1. Structure/Form

  • Participants (as determined by the directors of the Company (Board)) are invited to (Invitation):
    • acquire fully paid ordinary shares in the Company (Shares); and
    • apply for a loan (Loan) under the Plan. Participants will use the proceeds from the Loan to acquire the Shares.
  • The Board will determine the number and price of the Shares offered under the Invitation.
  • The Shares will be known as the Participants’ “Unvested Plan Shares” and will be allocated to a new company that will be set up who will be the trustee of the Plan (Plan Trustee).
  • The Plan Trustee will be established for the sole purpose of holding the Plan Shares on trust in accordance with the terms of a trust deed (e.g. the Company Executive Share Plan Trust Deed (Trust Deed)). However, the Participants will always remain the beneficial owner of the Shares, subject to the satisfaction of the Vesting Conditions set out in item 3.
  • The Shares will vest to the Participants on the specified date (Vesting Date) and will be known as the “Vested Plan Shares”.
  • If Participants accept the offer of a Loan, dividends will be paid on the following basis:
    • 70% of all dividends paid by the Company on any Shares must be used to repay the Loan outstanding until the Loan is fully repaid; and
    • the balance (of 30% of the cash dividend amount) will be paid to the Participants to enable the Participants to pay any tax on dividends paid by the Company. Any cash dividends paid by the Company are expected to be fully franked.
  • Voting rights on the Shares will be communicated by the Plan Trustee, and votes will be collated and pooled by the Plan Trustee, then put forward at a meeting of shareholders of the Company.
  • The Plan Trustee is able to buy back any Vested Plan Shares or sell them on the Participants’ behalf back to the Company upon cessation of the Participants’ employment (at fair market value).
  • Participants are unable to:
    • deal with (e.g. sell or transfer) the Shares until the Loan has been repaid. However, Participants are able to voluntarily repay the Loan at any time; and
    • acquire additional Shares under the Plan, without a formal invitation from the Company.

2. Eligibility of Participants

  • The Company may select Participants based on their ability to influence the Company’ financial performance or contribute to the achievement of the Company’ business objectives. This could be structured around the achievement of certain KPI’s by the Company and/or the individual. Importantly, the Plan can be drafted such that employees who leave employment on “bad” terms (e.g. for bullying or harassment) may be required to forfeit their shares for reduced or no consideration.
  • Participation in the Plan under any one Invitation does not automatically guarantee participation in a later Invitation for any Participants.

 3. Vesting Conditions

The actual number of Vested Plan Shares will be subject to the following conditions:

  • Participants remaining continuously employed by the Company until the Vesting Date;
  • the Company intervening in the vesting of the Unvested Plan Shares for certain reasons (e.g. misconduct of Participants or change of control of the Company); and
  • any other conditions that the Company deems appropriate.

I note, there are significant tax benefits deriving from the establishment of an ESS, however there are also potential tax detriments (in circumstances whereby the ESS is not structured in the correct manner). We will deal with this in more in detail in another blog post or otherwise feel free to contact us.

As noted at the beginning of this article, the above structure may not be appropriate for your organisation, it is merely an example of a structure I have previously implemented for startup clients.

Accordingly, if you would like further information, or would like to set up an ESS for your organisation, get in touch with me.

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