An ESOP is a discretionary trust arrangement, under which the trustees purchase and hold shares in the company which established the ESOP (“the Employer”) for the benefit of its employees. ESOPs are usually established in parallel with other employee benefit programmes, such as conventional share option and profit sharing schemes. Whilst the trustees of an ESOP will be independent of the Employer, nevertheless the Employer will want to ensure that the ESOP is operated in conjunction with any such other benefit programmes.
In recent years ESOPs have become increasingly popular vehicles for employee share ownership schemes. Whilst UK companies have been in the forefront of companies establishing ESOPs in jurisdictions such as Jersey, there are a number of overseas companies which are now establishing such schemes.
BENEFITS OF ESTABLISHING AN ESOP
An ESOP differs from other employee option arrangements, in that employees receive an option to purchase existing shares in the Employer from the trustees, rather than being granted an option by the Employer to subscribe for new shares: this has the benefit to the Employer of avoiding dilution of earnings per share. It has the further advantage of avoiding the need to obtain shareholders’ approval for the scheme, which will usually be required for a scheme involving the issue of new shares.
An ESOP can be used as a vehicle to create a market in a company’s shares: this may be of particular benefit for a privately held company or a company whose shares, whilst traded on a market, are not widely held or traded. For example, the Employer’s founder or major shareholder may agree to sell some or all of his shares to management and other employees: an ESOP can be used to accomplish this goal, in effect financing the sale over a period of time whilst at the same time providing employees with a mechanism to resell their shares to other employees, if they leave the service of the Employer.
Clearly, ESOPs can also be used as a conventional part of an employee benefit package, to incentivise management and staff to assist in improving the Employer’s share value, for their own benefit (through the ESOP) as well as for the benefit of all other shareholders.
ESTABLISHING AND ADMINISTERING AN ESOP
An ESOP is established by a trust instrument, which will set out the terms under which the trustees agree to hold the trust assets. The instrument will confer wide discretionary powers on the trustees, who will be permitted to finance the purchase of shares in the Employer in such manner as they think fit and to grant options over and otherwise distribute the shares which they purchase and hold in the Employer to such persons as they determine.
As already mentioned, shareholders’ approval is not usually required for the Employer to establish an ESOP, as it does not involve a fresh issue of shares; accordingly, the ESOP can usually be established by authority of the Employer’s board of directors.
It is important for the trustees of an ESOP to be totally independent of and to act totally independently from the Employer, though clearly the trustees will take account of the Employer’s recommendations as regards the grant of options to employees.
It is common practice for ESOPs to have trustees resident offshore, in order to avoid UK capital gains tax (or its equivalent in other jurisdictions): Jersey is the most frequently used offshore jurisdiction for the establishment of ESOPs.