Article Benefits and drawbacks of employee share schemes. 24 March 2023 Read time: 5 min Author Annie Lillico Lewis Expert Reviewer Lachlan Ezard, CPA Running a business is hard work. It takes grit. It takes focus. And getting a good team in place is crucial. Attracting and retaining top talent can be daunting for any business (particularly in such a tight labour market). If you’re finding the talent pool a wee bit on the shallow side, or are just looking to shore up your key staff, it might be time to consider launching an employee share scheme (ESS). In this article, we’ll dive into some of the benefits of employee share schemes and help you unpack whether one could be right for your business. Before we get into the nitty-gritty – a definition. What’s an employee share scheme? First thing’s first: What’s an employee share scheme? An employee share scheme is a program that allows your employees to purchase or be awarded shares in your business. This can be done through a variety of mechanisms, including employee share option plans (ESOPs) or employee share award plans (ESAPs). The idea is that by giving employees a stake in your business, they will be more invested in its success and will work harder to achieve it. Now, you may be thinking, “Why would I give away the company I’ve worked so hard to build to my employees?” Well, research from the Employee Ownership Association of Australia shows that employee-owned businesses present enormous opportunity and benefits for business owners, as well as their staff. The benefits of employee share schemes. 1) Attract top talent. Employee share schemes are still relatively new to many businesses (and completely novel in some sectors). So, they can be a real point of difference. A recent study from ASIC supports this view – it found that businesses with an ESS are more likely to both attract and retain high-quality employees. Further, in organisations where cashflow is often tight, an ESS can give you a competitive edge if you have to offer a lower base salary. This allows you to properly compensate your team members and provide an attractive offering to new starters, without adding to your day-to-day financial pressures. Whilst attracting and retaining staff is one of the many benefits of employee share schemes, there are some tax implications to be aware of. So get advice before launching yours. You can read more about income tax and capital gains tax (CGT) on employee share schemes here. 2) Lower turnover, improve engagement. Compared to non-employee-owned businesses, organisations with employee share schemes tend to have lower employee turnover rates and higher levels of engagement. ESS programs can be a great way to retain your key staff for the long haul. And when they’ve got skin in the game, your team members have higher levels of engagement and responsibility, and a greater sense of ownership over their work. Why might that be? When employees have a financial stake in the success of your business, they are more likely to feel invested in its purpose, mission and values. They are also more likely to work together to support each other, and less likely to be motivated by self-interest. 3) Improve productivity and decision-making. A study by the National Bureau of Economic Research found that employee ownership can increase productivity by up to 4%, and lead to higher profitability over the long term. In addition, an ESS program can help to align the interests of your employees with those of your wider organisation. When employees are also owners of your business, they are more likely to make decisions that are in the best interests of the whole company. Simply put – an ESS means your people are less likely to let self-interest affect their decision-making. 4) Increase shareholder value and harmony. An ESS can also help to increase shareholder value over the long term. But don’t just take our word for it. The National Center for Employee Ownership found that companies with employee share schemes grew 2.5 times faster than those without. That’s a pretty impressive statistic, if you ask us. Moreover, by converting your employees to shareholders, you instantly align the interests of the key parties to your business. Goodbye AGM thrown downs! Hello shareholder harmony. When everyone’s an owner, everyone’s goal is both a healthy workplace and strong growth. In addition, an ESS can help to reduce the agency problem, which occurs when managers act in their own interests rather than those of your company’s shareholders. In organisations with an ESS, employees are more likely to monitor each other, including managers, and ensure that they are acting in the best interests of the company. And, no surprise, this all leads to higher profits and ultimately, shareholder benefit. 5) Foster a culture of ownership and innovation. Finally, implementing an employee share scheme fosters a culture of ownership, empowerment and innovation. Employee-owners experience deeper responsibility for both day-to-day management tasks and high-impact decisions. Know that old saying: two brains are better than one? Well how about harnessing all the brains in your business? If done successfully, this can lead to sharp increases in innovation and in turn, a stronger, more successful business. The drawbacks of employee share schemes. Now, we know what you’re thinking… “This all sounds too good to be true. So – what’s the catch?” Am I right? While there are many potential benefits of employee share schemes, it’s also important to consider potential risks or drawbacks. The main drawbacks of employee share schemes include: 1) The cost and administrative effort. One of the biggest drawbacks of employee share schemes is the set-up cost and the administrative burden it can place on your business. Implementing an ESS requires careful planning, legal and financial expertise, and ongoing administrative support. Depending on your own skills and expertise, this will require an investment of time and money on your part. Get a hand at the outset to ensure your ESS is set up properly and you’ve considered the tax implications for your business. 2) Dilution of existing shareholders. The risk of dilution of existing shareholders is another potential drawback. Granting your employees shares in your company can dilute the ownership stake of existing shareholders. This can be a concern for some shareholders, particularly if they are not offered the opportunity to participate in the scheme themselves. However, there are many different types of schemes to choose from, ranging from stock options to direct equity ownership. Each employee share scheme has its advantages and disadvantages. So it’s important to do your research and choose the option that best suits your needs. 3) Drop in share price. Additionally, there is always the risk that the value of the shares could decrease, leaving your employees with less value than they were originally granted. This can be a disappointment for those who were counting on the value of their shares as a significant portion of their remuneration package and overall compensation. However, it’s worth noting that there are ways to mitigate these risks. For example, implementing a vesting schedule can help ensure that employees remain with your company for a certain period of time before being able to fully exercise their shares. This can help mitigate the risk of both turnover and dilution. It’s also important to be transparent and communicate clearly with your team about the risks and potential benefits of employee share schemes. By setting realistic expectations at the outset and providing ongoing communication, you can help ensure that your employees are fully informed and engaged in the ESS process. Weighing up the benefits and drawbacks of Employee Share Schemes? Implementing an employee share scheme isn’t a one-size-fits-all solution. Nor is it appropriate for every business. It’s just one of the tools in your arsenal as your organisation grows, shifts and modernises. From improving employee retention and motivation, to aligning employee and shareholder interests, to providing a tax-efficient way to reward your team, an employee share scheme can be a valuable tool for businesses looking to grow and succeed. And, while there are potential drawbacks of employee share schemes, these can often be mitigated with careful planning, good communication and ongoing support from the pros. As with any business decision, it’s important to weigh up all the potential risks and benefits before moving forward. So be sure to take the time you need to carefully consider all the factors. Then, sanity check your plans with a professional accountant, tax or business adviser before moving ahead or making any commitments to your employees. Whatever you do, do yourself a favour and add “explore employee share scheme” to your next management meeting agenda. Who knows? With the right approach, an ESS could be just the thing you need to take your business to the next level. Learn more about Employee Share Schemes. More articles from this series: How employee share schemes are taxed in Australia. Understanding the difference between ESS, ESOP, and ESAP. What’s the employee share scheme deferred taxing point? Or contact us to get a hand from our team.