ESOP: The Employee Stock Ownership Plan

In this short guide, we’ll cover everything you need to know to decide which employee stock ownership plan is the right for your business.

Contents

1. What is an employee stock ownership plan?
2. Do we have ESOPs in the UK?
3. How does an ESOP work? 
4. What are the advantages?
5. What are the choices?
6. ESOPs made easy
7. Further reading
   

What is an employee stock ownership plan?

An employee stock ownership plan (ESOP) or employee share option plan is a way of giving your employees - and the consultants and freelancers you work with, if you’d like - a stake in your business.

It’s a great way to incentivise them to do their best to grow your business, get them bought into your company’s vision, and boost employee retention.

Do we have ESOPs in the UK?

Before we go any further, let’s take a step back and clarify a few terms.

ESOP is a term most often used in the US, Australia and India. In those countries, an ESOP is a very specific employee benefit plan that needs to follow a strict set of rules and regulations.

Here in the UK, an ESOP is a catch-all term that can refer to either an:

• Employee share option scheme
• Employee Benefit Trust (EBT)

Usually the former.

So, if you’re a UK-based business owner who’s been left scratching your head at all the talk of S corporations and 401(k) contributions while you’ve been reading up on ESOPs, that’s why.

Those are all to do with the American ESOP - which means something totally different here in the UK. You’re in the right place now, though.

So, let’s dive into what an ESOP can do for your UK-based business and what the best share scheme might be for you and your team. 

How does an ESOP work?

There are multiple choices available to you when it comes to giving your employees equity in your business (we’ll dive into which might be the best fit for you later).

Whatever employee stock ownership plan you go with, they all work fundamentally the same way.

You grant your employees share options, meaning they can one day own a small part of your business.

They might also receive dividends from your company’s profits and voting rights at company meetings, depending on what kind of equity you give them.

Then, the more successful your business becomes, the more valuable your employees’ share options will become.

That means your people will get a bigger payday if your company is acquired or has an Initial Public Offering (IPO) and joins the stock exchange as a listed company.

At the same time, the more people you give equity in your business, the more existing shareholders’ stake in the company is reduced. So, your current shareholders might need convincing that reducing their share in your company will pay off in the long run.

Which brings us to…

What are the advantages?

Setting up an ESOP and giving your people equity in your company can transform your culture - and your business’s fortune.

Here are a few research-backed benefits that come from an employee stock ownership plan:

Attract top talent...

An employee with equity in a company that ends up being acquired or goes to IPO gets the best of both worlds: a steady paycheck each month and potentially, shares worth a lot of money.

We asked 2,000 Brits whether a share scheme would influence their decision if they were weighing up two otherwise identical job offers - one in three said that it would.

One third of job-seeking Brits would be swayed by a share scheme.

As a startup or scaleup, you might not be able to match the kind of base salary that more established companies with deeper pockets.

An ESOP helps you make up the difference by giving new hires equity in your business, (a business they’ll then be very incentivised to try their best to grow).

And, contrary to what you might think, you don't have to give huge amounts. Plug some numbers into our handy calculator and see for yourself.

...And keep them

Do you know that replacing a salaried employee can cost as much as six to nine months of their salary?

And that figure doesn’t include indirect costs like the effect a top performer leaving has on team morale - and the drop in productivity while you get their replacement up to speed.

Replacing an employee can cost as much as 50-75% of their salary.

The kicker? According to Gallup research, over half of voluntarily departing employees say their company could have done something to prevent them from leaving their jobs.

And share schemes are a proven way to increase employee retention, hold on to your best people, and keep those hiring costs down. People are simply a lot less likely to leave your business when you’ve given them a slice of the pie.

We call it the Ownership Effect, and it makes a massive difference to people's mindset.

Boost productivity and performance

Every study we've seen shows that companies that give their team a stake in their business are more productive, grow faster, and are even more likely to weather the storm during a financial downturn.

And it’s no surprise why. How much your employees’ shares end up being worth is in their - and their teammates’ - hands. That’s a powerful incentive for your people to do their best work as well as try to improve the performance of their whole team.

Improve employee engagement

Giving your people equity in your business will throw rocket fuel on employee engagement across your business. Here’s why:

When a teammate owns shares or options in your company, they win when your business wins.

That means hitting their KPIs is about a lot more than just getting closer to a pay rise or a promotion - it’s playing their part in increasing the value of a business they have a stake in.

Plus, your employees are bound to feel trusted and appreciated when their boss gives them a share of the business they founded – two essential ingredients for engagement.

Build a more valuable business

Since engaged teams are more productive and less likely to be off work sick, an ESOP can have a big impact on your business's bottom line.

Companies with highly engaged employees are 21% more profitable, according to Gallup.

So, while your company’s original stakeholders might have a smaller slice of the pie than before an ESOP, it could end up being worth a lot more - leaving everyone better off.

What are the choices?

Sold on the benefits of an ESOP and want to set one up ASAP? The first step is to select the right scheme for your business in particular.

When it comes to ESOPs, there are two routes you can go down: approved and non-approved.

Approved share schemes

There are four HMRC-approved share schemes. These are the best choice for most businesses since they’re more tax-efficient for you and your employees.

However, they take longer to set up, as HMRC may need to approve your scheme or valuation before you can launch it. The four schemes to choose from are:

1. Enterprise Management Incentives (EMIs)
2. Company Share Option Plans (CSOPs)
3. Share Incentive Plans (SIPs)
4. Save As You Earn (SAYE)

An EMI scheme is a smart choice for eligible UK startups, scaleups and SMEs. It offers the best tax advantages you can get for both employers and employees.

However, your business will need to have fewer than 250 employees and assets of less than £30m to qualify for an EMI scheme. If you don’t fit those criteria, the next best thing is usually a CSOP, which also offers some healthy tax advantages.

Take our two-minute quiz to find out if EMI is an option.

SIPs and SAYE schemes offer great tax advantages, too. But they only really make sense for companies with hundreds or thousands of employees. So, they’re probably not the right fit for your company if it's just begun.

Unapproved share schemes

There are a number of other ways of giving people shares. These schemes are very flexible and quick to set up, as they don’t require HMRC approval. But the downside is they come with fewer tax benefits.

1. Unapproved share options, which are extremely flexible and can be used to incentivise employees as well as non-employees like contractors, advisors, or consultants. 
2. Growth shares, which are ideal if you’re looking to bring people into your business after it’s built up some initial value. Recipients only share in the business's growth in value from when they come on board, as opposed to benefitting from the existing value.

Choosing the right share scheme is crucial. If you're unsure, book a free consultation with one of our equity specialists, tell us about your business and we'll help you find your ideal match.

ESOPs made easy

Setting up an ESOP by yourself is no mean feat. It can get complicated quickly, and traditionally, it involves a lot of paperwork. And let's face it, you have a million other things to do.

Instead of wrestling with the ins and outs of equity management yourself, why not use software? And not just any software but a purpose-built, FCA-regulated platform fully synced to Companies House?

We’re all about removing the cost and complexity to help UK business owners like you design, launch, and manage schemes that suit their needs - making it easier than ever before to unleash the power of equity.