I'm looking at starting an ESOP in my business. I'd like to know if anyone here can tell me about how they've structured an ESOP or similar arrangement in their company? In particular, what percentage of your company would you look at allocating to an ESOP pool? What vesting period did you choose and did you have conditions upon vesting? Any other considerations that should be thought of in advance and included in the contracts?
If anyone has any ideas to throw out here, relating to ESOPs or alternatives that have been implemented in their current workplaces, make your voice heard ;) . I've got some ideas from 'The Remuneration Handbook for Africa - by Dr. Mark Bussin', but I'd love to hear from people in businesses with ESOPs and from people that have founded company's and created an ESOP.
NB questions include (i) whether its a general ESOP for all staff where staff ideally don't actually acquire shares but participation rights in a trust that holds the shares or (ii) a targeted ESOP for key staff, where key staff can be incentivised with direct shareholding coupled with buy-back clauses if they resign. Percentages can vary greatly depending on the desired outcomes, including an ESOP as one way of addressing broad based BEE. In my view, most entrepreneurs give away a bit too much too early fueled by massive amounts of optimism and later wish they'd held back a little bit more for themselves or other financial partners. I would always try to link vesting to particular conditions and tax planning is key to reduce CGT and PAYE.
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Thanks for both your answers! I'll look at getting in touch with someone from Bowman Gilfillan.
The establishment of ESOP's can be quite tricky and the tax treatment of the ESOP shares needs to be considered.
The question of the number or value of shares to be included depends on the objective of the scheme. For some, it is about getting employees incentivised to participate in the success of the company - in which case the percentage of shares in the ESOP needs to be significant. Other employers want to increase the gross remuneration of employees but want to do so in a tax efficient way - ESOP shares can be a good way of doing this.There are other considerations: some ESOP's are simple - the employees at the time of the ESOP are the direct beneficaries but others use a discretionary trust or a vesting trust structure. It is another layer of administration/expense but permits some flexibility to include future employees and fixes the number of ESOP shares. In smaller companies, it is possible to create a "phantom" ESOP without many of the complications. Here, employees participate in a profit share arrangement that works as if they had owned the ESOP shares but do not actually own the shares. Another variation are option shares. The right to buy shares at a future date, but fixed now (i.e. the employees participate in the growth of the equity value. ESOP's can work to give employees a stronger sense of shared destiny but can complicate things - an ESOP which is a shareholder has the rights of other shareholders including minority protection rights.
The tricky part comes in the question of when vesting takes place or the conditions of vesting. One needs to be careful about not inadvertently creating a "vesting event" for tax purposes - this means that employees do not want to have the ESOP shares form part of their taxable income in one year without the actual income to pay the additional tax.