Employee share schemes, also known as employee share purchase plans or employee equity plans, offer workers the opportunity to become invested in the company they work for on a deeper level while potentially getting started in investing for the first time.
When you own company shares, the value of your shares is tied directly to the performance of the company you work for. This gives you a direct interest in the success of the company and makes you more likely to work hard to ensure the company performs well.
In this short article, we’ll get you up to speed on:
- The benefits & downsides of employee share plans
- What you should know before you sign up
- Understanding the tax benefits & capital gains tax implications
How do employee share schemes work?
They are basically an employee stock ownership plan.
Employee Share Schemes (ESS) are when employees can purchase shares directly at a discounted price, while Employee Stock Option Plans (ESOP) are the promise of shares that you have the option of purchasing after a period of time. Some also use Employee Share Award Plan (ESAP) to refer to shares awarded to employees as a reward or part of a salary package.
Employee Share Purchase Plans
If you purchase shares in the company yourself, you might pay for shares through a salary sacrifice arrangement over a period of time. However, you can also buy shares outright, or re-invest dividends into more shares.
Because shares are usually offered as an additional employee benefit, or to attract and motivate employees, companies usually provide them at a discounted rate.
As a Reward or Employee Bonus
Key employees or high-performing individuals might be offered a share package as a reward for performance or as an extra bonus on top of their salary, in lieu of cash bonuses. Increasingly, senior employees are coming to expect share incentives of this kind as part of their salary package. Some companies also provide profit-sharing or employee equity plans, which are slightly different ways of providing ownership for employees.
This flexibility with your salary package, rather than receiving just cash payments, can be particularly helpful for those earning a high income as a way of lowering tax obligations.
The Pros and Cons of Share Schemes for Employees
There are a few direct benefits of employee share schemes, as well as a few things you should be aware of before you participate.
✅ Pro: A Lower-Cost Way to Start or Grow Your Portfolio
If you are offered shares with your company of employment, you may be entering the share market for the first time. As such, they may form the basis of your investment portfolio and provide you with a way to begin growing your wealth through further investment.
They also create the opportunity to start or grow your portfolio, at low or no financial cost to you (discounted shares or a ESAP program are particularly accessible). If managed correctly, this investment portfolio could, over time, have a direct impact on your financial success and security.
✅ Pro: An Opportunity to Share in the Success of The Company
While it’s not necessarily a financial benefit, one of the benefits is you can have a greater sense of belonging and ownership to your company. With the opportunity to be a company shareholder, your hard work can have a direct impact on the financial success of the business – and therefore your share portfolio. One of the biggest examples of this was the Canva share sale, which made some of the earliest employees with larger share holdings into overnight millionaires. This is what every employee dreams of when it comes to holding shares in the start-up they work for, but it doesn’t often happen this way!
❌ Con: They can be complicated & have restrictions.
There are different types of share schemes, with different acronyms. Understanding all the details of the scheme offered by your company can take some research. There are also restrictions attached to many ESS, such as performance metrics, limitations on buying and selling, and the potential for not retaining the shares if you stop working for the company.
❌ Con: A Lack of Diversification
If you participate in an employee share scheme without having other investments in your portfolio, it’s likely that all of your income streams are tied into one company. With both your salary and the performance of your investment portfolio dependent on the success of your employer, you could leave yourself open to a lot more investment risk.
A diversified investment portfolio is one of the keys to financial success and security. By dividing your wealth across shares from a number of different companies, in a variety of industries, you are better prepared to weather any fluctuations that may occur in the stock market.
❌ Con: Tax Implications When Vested
If your workplace has an Employee Option scheme, you would likely have been told that you must wait for a specified vesting period to pass before you’re able to own shares in the company. This vesting period usually lasts for a number of years, after which you’ll be able to purchase your vested shares and gain complete ownership over them. These vested shares become available at the price set out when you originally received your options, known as the exercise price, which is usually lower than the current market price of the shares.
However, the difference between what you paid and the market price can be considered a benefit, and this benefit is added to your assessable income and taxed at your marginal tax rate. However, depending on how your ESS is structured, you may be able to defer paying tax on your shares until you sell them. This means you’ll be paying capital gains tax on the profit from the shares instead.
The tax on share schemes can vary from Australian businesses to International businesses, as well as between different types of share schemes, and the different times you receive and sell them. So we recommend finding a financial adviser or accountant who can help you navigate this complexity!
The Benefits of Employee Share Schemes for Employers
These kind of schemes can definitely bring lot of benefits to your employer, even though they also bring a lot more administration costs for Australian companies! A few of the benefits your employer can expect are:
✅ Create a Culture of Ownership
One of the most notable advantages of Employee Share Schemes is the culture of ownership and personal investment that they can create among permanent employees. Having a financial interest in the success of the business is a powerful driver of productivity and retention.
Larger companies typically offer ‘ordinary shares’, which give an equity investment in the company. In a smaller or unlisted company, you may get dividend payments only, which means you don’t get other shareholder rights, such as a vote at the annual general meeting.
✅ Compete with Higher Salaries
It can be challenging for some businesses, particularly if they are smaller, to attract and retain top talent. Creating an ESS can create a promise of future wealth, particularly for start-ups or businesses in growth phase that can’t afford to pay the highest salaries on offer.
✅ Receiving Tax Concessions
There are certain tax concessions available for eligible start-up companies, as well as tax-deferred arrangements (which help employers avoid giving their employees a large boost in taxable income without the cashflow to pay the tax bill!). These can make ESS programs more appealing to start-ups by reducing the tax cost.
Before You Buy into an Employee Share Scheme
Even though you’re working for the company, you may not want to purchase shares.
Of course, if you’re given shares as a performance bonus or for some other reason, that is a different thing. However, there are some things you should check before you sign up.
- Can you reasonably expect the shares to increase in value?
- Are you able to sell the shares, and if there are restrictions around when you can buy and sell
- what are the tax implications of owning these shares?
- Will you receive financial benefits such as dividend payments?
- Will you have to give up the shares if you leave the company
What next?
As employee share schemes can be extremely complicated, it’s important to get professional advice or a second opinion on the tax implications or the specific structure of the scheme. It’s also helpful to get guidance on how to make the most of your portfolio (and don’t forget to diversify!).
Please do reach out for financial advice if you need it.
