Is now the right time to consider employee share ownership?

September 17, 2020

The use of employee share ownership schemes such as Employee Benefit Trusts (“EBTs”) and Employee Stock Ownership Plans (“ESOPs”) has expanded greatly since they were introduced over four decades ago. In addition to incentivizing key employees, employee share ownership plans are an excellent tool for attracting and retaining talent, succession planning and stimulating company growth, and may sometimes also have some tax benefits for the company or its employees. The terms “EBTs” and “ESOPs” are essentially identical and often used interchangeably. However, it is worth noting that Share Option schemes can come under the description of an ESOP, but not an EBT as it does not require the use of a trust.

Even in the midst of a global pandemic, companies still struggle with retaining and attracting top talent. Many employers are finding new ways to stay competitive by offering perks such as flexible hours and remote working, trendy offices and corporate gym memberships. Promoting employee share ownership through Employee Benefit Trusts ("EBTs") and Employee Stock Ownership Plans ("ESOPs") has also grown in popularity as companies realize the potential in incentivising and keeping high calibre employees or staff, fostering loyalty and recruiting potential job candidates.

How EBTs and ESOPs work

Employee share ownership can be implemented in a number of ways. Employees can buy stock directly, receive stock options, be given stock , obtain stock through a profit sharing plan, or become owners through worker cooperatives where every employee participates in some form of decision-making (to a greater or lesser extent). However, EBTs and ESOPs have proven to be the favoured options when it comes to structuring an employee-owned shareholding.

An EBT is effectively a discretionary trust which acquires and holds shares in a company for the benefit of employees. Instead of paying cash bonuses or granting stock options directly to employees, an employer can make contributions (usually cash or shares) to an EBT which holds the assets until an employee becomes entitled to them. Employees wishing to exit the EBT can offer their shares to be sold on the open secondary market.

An ESOP is an employee benefit scheme that enables employees to participate in the ownership of the company without having to actually invest any of their own money. The company offers ‘phantom’ shares to employees then typically holds the shares provided in a trust until the awarded shares are vested on the employees.​ These features can also be seen in EBTs. Adopting an ESOP helps to align the employee’s interest with those of the shareholders, thereby encouraging employees to have a vested interest in the sustainable growth of the company.

All in all, both EBTs and ESOPs fundamentally serve the same purpose – to act as a discretionary trust set up by a company as part of its remuneration strategy for employees.

Unlocking the benefits of EBTs and ESOPs

There are a number of advantages to using an EBT or ESOP for both business owners and employees.

For business owners:

  • It provides a flexible exit strategy. ESOPs are excellent tools for succession planning when it comes to liquidity and transition, as it allows for both instant and gradual ownership transition.
  • It boosts retention and motivation amongst key staff members.
  • It can be used to avoid a dilution of shareholdings.

For employees:

  • Assets held in an EBT are protected from insolvency.
  • It can sometimes offer tax benefits to companies and their employees alike.
  • It gives employees a greater sense of belonging because they have an actual stake in the company and its performance.

For these reasons, EBTs and ESOPs can be ideal for many businesses. However, employee share ownership plans are not always a good fit for all companies. In fact, an EBT or ESOP typically works well for companies with these key traits:

  • Has a demonstrated history of profitability and solid cash flow
  • Has an employee-centered culture with low employee turnover
  • Has an experienced management team

Because of this, we often see ESOPs in family-run businesses and multi-owner companies. EBTs and ESOPs have been increasingly used in start-ups, most notably those in the fintech sector, and listed multinationals from a broad range of different industries.

When employee ownership works – a case study

Employee share ownership plans are utilized by many successful companies around the world. One such company is Huawei, a telecommunications and consumer electronics company from China.  

Huawei adopted an ESOP program in 1990 through its employee union, three years after the company was founded. At the time, the company needed money for marketing and expansion, but instead of seeking external funding, Huawei introduced an ESOP – making 15% of its stock available to employees. As of 2018, Huawei had 96,768 shareholding employees.

For Huawei, the adoption of an ESOP helped to align the interests of its employees with that of the company, and was instrumental to the company’s rapid growth. Over the years, several studies have found that Huawei’s ESOP strategy was highly effective in incentivising key members of staff and enhancing employee productivity, and played a key role in helping the company achieve corporate efficiency and growth even through volatile periods.

The current Asia outlook

Despite the current unfavourable economic situation, employee share ownership plans remain indispensable to many businesses. Offering an EBT or ESOP at this time when share prices are low translates to relatively low costs for the company itself and represent greater potential in value growth in the long-run. It can also help to attract potential staff at a lower cost and offers more room for asset appreciation to employees.

Whilst employee share ownership plans are already widespread in other parts of the world, businesses in Asia have only just started to adopt employee incentive plans in recent years. Given the growing reputation of EBTs and ESOPs as effective tools for invigorating business development, we expect to see an increase in the adoption of employee share ownership plans in the Asian market over the next few years, particularly in start-ups.

Early planning and having specialized expertise is essential

Introducing an employee share ownership plan such as an EBT or ESOP is no easy task. These types of schemes involve extensive planning as the procedures for account and allocating stock differ from methods used for an ordinary profit-sharing plans. It requires stringent tax planning, setting up a trust, establishing a platform for information sharing, transferring the cash (to purchase the shares) or the shares themselves to the trustee of the EBT, reporting to the relevant regulatory authorities, managing the inflow of funds and more.

Furthermore, there are many complex requirements and regulations when it comes to adopting an EBT or ESOP. In order to help save time, money and any legal issues, it is important that companies start preparatory work early and talk with a professional to determine the best path for their business.

When used correctly, EBTs and ESOPs can prove to be powerful tools for both management and employee beneficiaries.

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