Employee share option plans: Everything you need to know
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Congratulations! You’ve just landed a new role (or maybe your current role is being updated), and they’re offering you an employee share options plan (ESOP) plan. If it’s your first time being offered an ESOP, it can seem complicated and filled with tons of unfamiliar jargon.
But there’s no need to stress; we’ve got you! Below, we’ve broken down the key terms you’ll encounter in your ESOP journey.
At Orchestra, we’ve worked with thousands of employees and employers across Australia and New Zealand on their company share plans and are here to simplify the process! We want you to feel informed and empowered that you’re making the right decision for you.
What is an employee share option plan?
If it’s your first time receiving an employee share options plan (ESOP), it can seem like a complicated process and filled with unfamiliar jargon. So, what is an ESOP in simple terms?
An ESOP is when you (the employee) are given the right to buy (‘exercise’) company shares in the future at a predetermined price. The benefit of this is that you don’t need to outlay any cash initially but have the opportunity to buy the shares in the future at a pre-agreed fixed price and benefit from the potential increase in the company’s share value.
It takes time to gradually earn ownership in a company and the right to exercise your right to purchase shares. This is known as a ‘vesting’ period. Depending on the company you work for, vesting can happen at various frequencies, such as monthly, quarterly or annually.
For many years, companies have used ESOPs as a tool to reward, retain, and attract new talent (particularly within senior leadership roles) to the business. It’s a win-win situation for you and the company, as not only do you own a stake in the company, but you also receive recognition for your contributions to the company.
Some well-known companies that have ESOP schemes in place include Facebook, Microsoft, Google, and Amazon. These companies have effectively used ESOPs as a tool to attract and motivate the best employees through an ‘ownership’ mindset. In New Zealand, there is a growing community of private companies that offer ESOP schemes, including Orchestra.
How do employee share option plans work?
An ESOP scheme follows the below lifecycle:
- Options offered: During this stage, share options are granted to employees via an offer letter at a fixed exercise price. Keep these legal documents safe and handy, as they include all the details and rules you need to be aware of to exercise your options.some text
- In your ESOP offer letter, you will see the specific number of company shares you have the opportunity to purchase (‘exercise’);
- Learn the criteria for how share options are earned (‘vested’);
- The details on the minimum hurdle at which options become ‘vested’ (earned);
- Along with the deadline by which share options must be exercised (‘expiry’).
- Options vested: Employees have earned the right to exercise their options (purchase shares at the set fixed price).
- Exercise options: An employee decides to purchase company shares at the exercise price.
Sell options: The final stage of the ESOP lifecycle is when an employee sells their shares, typically at an ‘exit’ milestone, such as a company acquisition or IPO event.
How are the benefits for employees?
While investing in property, the share market and private equity can be out of reach for many younger employees in the current economic environment, ESOP provides them with an opportunity to diversify their investment portfolio in a more accessible way. As a pathway to becoming a partial owner in a company, ESOP can be a long-term wealth creator, as the higher the company value, the more your employee options value increases.
Other benefits can include the sense of pride that comes with a company's recognition and acknowledgement of the value you bring to the company. Being an ESOP employee also provides you with more clarity and insight into the inner workings of a company, setting you up to succeed and thrive in your role.
What to be aware of with an ESOP
Employees should be aware of several things when considering an ESOP. These include leaver protection, which allows a company to withdraw ESOP rights if an employee leaves the company and is deemed a ‘bad leaver’ (misconduct)—leaving the company on bad terms.
Another consideration is tax obligations. Tax will typically apply at the point when you exercise options and is most commonly the responsibility of the employee to pay. The taxable amount is calculated on the difference between the market value of the shares at the date of ‘exercise’ and the value at the ‘strike price’. This will be your taxable income. It’s important to be aware that even if you are not selling your new shares immediately, you will still pay tax on the capital gains.
We recommend you consult with a qualified tax professional or financial advisor to obtain accurate and personalised advice regarding the tax implications of ESOP or any other financial matters. It’s important you have a thorough understanding of the finer details before making a financial decision.
Interested in learning more? Talk to your employer about whether an ESOP scheme is available at your company or ask them to get in touch with Orchestra to talk about setting one up.
Head to our blog for more information on employee share option plans.
