What is Employee Share Ownership Plan(ESOP)?
Employee ownership is a different way of thinking about business. It targets long-term sustainability by recognising that employee/owners are more committed to developing innovative products and processes. The result is competitive advantage and lasting success – in good times and bad- Sir Stuart Hampson, former Chair of the John Lewis Partnership
Employee Share Ownership Plans, or ESOPs, are a mechanism used to allow employees to own the company they work for, with the express intention that they will think and act like business owners.
The primary objective is to create a structure with which your employees’ lifestyle and financial goals are aligned with your business objectives. The result? A cohesive and committed team that is single-minded about working toward and sharing the benefits of a successful and profitable business.
Why do workers get into ESOPs?
In a recent Melbourne University study a group of employees were asked certain questions and below is what employees ranked as the most important elements of an ESOP
- Financial payoff (68%)
- Fair treatment (67%)
- A sense of community (59%)
- Employee influence on management of the Company (42%)
- Individual influence on decisions affecting daily work (38%)
(Michelle Brown, Rowan Minson, Ann O’Connell and Ian Ramsay, ‘‘Why do Employees participate in employee share ownership plans?’ (Employee Share Ownership Project, Melbourne Law School, The University of Melbourne, 2011)
So ESOPs are used for:
- Savings vehicle – A major attraction ESOPs have for employees is that they accumulate savings and acquire and hold shares. Most plans have a long term focus 3 – 7 years.
- Participation - Employee ownership gives employees a sense of community, allows employee engagement and involvement, as part owners they feel part of the decision making process.
- Succession planning – When the owner (or owners) want to retire (or change their business direction) and need to sell. In these instances an ESOP can be an effective employee buy-out instrument.
ESOP companies have improved performance, higher profits and better staff retention than other businesses. The ability to attract, retain and motivate people to peak performance means being able to attract and retain business – and it is a major source of competitive advantage. In fact, it can mean the difference between success and failure.
“Productivity is, in the long term, the key to building a more internationally competitive economy – one that can produce more output from its existing resource base; one that can grow faster without fuelling inflation and consequently, driving up interest rates…”
- Kevin Rudd, “Towards a Productivity Revolution”, Speech to The Australian/Melbourne Institute Conference, 28 March 2008.
Here’s what the research says:
- ESOPs appear to increase sales, employment and sales per employee. (Drs. Joseph R. Blasi and Doulas L. Kruse, School of Management and Labor Relations, Rutgers University).
- ESOP companies that combine employee ownership with a participative management style grow 8-11 percent per year faster than they otherwise would have been expected to grow based on pre-ESOP performance. (National Center for Employee Ownership. Harvard Business Review. September/October 1987).
- Compared to 500 private non-ESOP companies, ESOP companies paid better benefits, had twice the retirement income for employees, and paid higher wages than their non-ESOP counterparts. (“Wealth and Income Consequences of Employee Ownership: A Comparative Study from Washington State.” Kardas, Peter A., Scharft, Adria L., Keogh, Jim. November 1998).
- Studies between ESOPs and productivity growth have found greater productivity and profitability in the first few years after a company adopts an ESOP. (Dr. Doulas L. Kruse, School of Management and Labor Relations, Rutgers University. 1995).
- The number of ESOPs in the UK increased by 10% during 2012 (National Centre for Employee Ownership February 2013).
Peak performance trust
What would it mean to your business if your employees were as committed to achieving success as you are?
One of the most innovative vehicles through which to provide employee share ownership is a customised Peak Performance Trust (PPT) – a new type of ESOP that has been developed by, and is only available through, Succession Plus.
With a PPT, the employer creates an investment trust into which it makes contributions on behalf of, and for the benefit of, its employees. It makes a commitment to investing a predetermined amount of money into the trust on a regular basis, contingent upon participating employees achieving predetermined performance outcomes. As the profits increase, so too does the percentage share that employees can benefit from. If profits are not increased, then no further allocation of funds is made to the PPT.
How Peak performance trust (PPT) works?
- The Employer will invite employees to participate in the PPT. Qualification is usually related to years of employment.
- A net profit benchmark and a percentage of profits above this benchmark to be shared to the PPT must be calculated. For example, the Employer must pay 35% of the net profits generated by the Employer over $400,000. If the Employer’s net profits for the year are $500,000, then 25% of $100,000 (i.e. $25,000) will be contributed to the PPT.
- The Trustee will use this contribution to invest in shares in the Employer. Because the PPT has a share in the Employer, and Employees have a share in the PPT, increased profits will result in an increased value of each employee’s indirect share in the Employer. Further, because this is the only type of investment, the equity value of the trust will always match the equity value of the Employer.
- Dividends will also be paid annually to employees in proportion to the units held.
- Qualifying discounts can be set up to govern the length of time that an employee must continue to hold his/her Employee Units until that person is entitled to 100% redemption value.
Case Study – ‘ABC Financial Planning Pty Ltd’ – PPT for succession
In the case of this client, the investment strategy for the PPT is simple – it will only ever purchase direct shares in the business, thereby giving participating employees an indirect ownership of the business’s equity. Its staff receive dividends and a bonus reward based on the profit performance of the practice. If the practice was to ever be sold, the PPT would benefit from the capital sale, and indirectly, the employees would receive part of that capital gain.
Based on this simple strategy, the value of the PPT automatically replicates any change in the value of the business, therefore employees directly benefit (or otherwise) from any change in value which is largely driven by profit performance and is something that the employees can directly influence. Over time the employees can either purchase a majority stake or 100 % of the business, providing a viable succession solution with predetermined valuation, funding and timing mechanisms.
Advantages of peak performance trust(PPT)
The benefits of participating in a PPT for both the employer and employee can be considerable. This, unlike any other type of employee incentive tool, truly ties the employee’s financial and lifestyle goals to the performance of the company. It is the ultimate ‘golden handcuff’ for your high-performing staff.
- Is affordable for the business;
- Encourages ongoing profit improvement through rewards linked to performance;
- Is tax effective for both the business and participating employees;
- Reflects the culture and values of the business;
- Supports employee development;
- Rewards employees who make a substantial contribution to the business;
- Reflects different individual motivations;
- Does not result in additional administrative work;
- Is easily understood, controlled and managed;
- Is appropriate for both the long and short term;
- Complies with all current and likely Australian taxation and legal requirements;
- Assists in funding succession planning and new business opportunities;
- Helps to influence company culture;
- Gives the company a competitive advantage in recruiting, motivating and retaining high performance staff;
- Assists employees to achieve their financial and lifestyle goals.