What is an Employee Share Option Plan (ESOP)?

What is an Employee Share Option Plan (ESOP)?

Ian Aldridge WebsiteAuthor: Ian Aldridge, Progressive Legal


An Employee Share Option Plan (ESOP) is a strategic tool to foster employee engagement and drive business growth. By integrating ESOPs into their business model, companies can enhance employee motivation and align personal interests with corporate objectives, leveraging these plans for sustainable growth and resilience, even in challenging economic times.

In this article, we’ll delve into what exactly an ESOP is, how ESOPs are different from Employee Share Schemes, how ESOPs work, whether ESOPs are the right choice for your business, and how you can create an ESOP with your company.

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What is an Employee Share Option Plan (ESOP)?

An Employee Share Option Plan (ESOP) in Australia grants equity to employees in the company they work for, providing employees a greater sense of ownership, boosting their motivation, and giving them a personal interest in driving value for their company. For this reason, and for certain tax advantages, ESOPs can be beneficial to company owners. 

With ESOPs, employees are given share options of a company at no up-front cost and vest them over time until eventually purchasing them back at fair market value. When employees leave the company, they force-sell the shares back to the company. The share options are not available to be purchased as ordinary shares until after they are vested, meaning employees do not get voting rights or dividends until the share options are exercised.  

Employees receive share options in addition to a salary, they can also purchase the shares outright through an employee share purchase plan (ESPP). Companies should consider increasing employee shareholding since it motivates employees, and is statistically shown to improve business growth, even in recession periods.

How are ESOPs different from Employee Share Schemes (ESSs)?

The ATO has made employee share schemes (ESSs) more attractive to employees with the Start-up Concession, a 2015 initiative which reduces tax liability for employees’ shares.  

While ESOPs offer share options, ESSs issue shares directly to employees. In Australia, at least 75% of full-time employees with 3 years tenure are entitled to ESSs. ESOPs have no such restriction and can be offered to any number of employees.  

ESSs require no engagement from employees whereas ESOPs require that employees vest their options in the company until realizing them as ordinary shares. Participating employees of ESSs receive dividends and voting rights instantly, because they are granted ordinary shares off the bat, unlike with options.  

Since ESSs offer shares outright, they are subject to the 50-shareholder limit of private companies. ESOPs circumvent this rule.  

How do ESOPs work?

Share options are received by employees as fringe benefits. A share trust is created where employees’ shares are invested into it. The company can buy back existing shares or create new shares to entitle to employees.  

Should the company not have the liquidity to buy or issue new shares, a loan is taken against the shares which the company repays, and as it repays the loan, it releases the share value to the employees’ trust proportionate to the repaid debt amount.  

Where the company must absorb debt to create new shares, it becomes a leveraged employee share option plan (LESOP). There are benefits and drawbacks of having leveraged vs. non-leveraged ESOPs.

Leveraged Employee Share Option Plans

A leveraged ESOP offers immediate capital. It also may provide companies with tax advantages, because instead of using cash to purchase shares, it uses debt.  

Furthermore, the purchase of shares through the share trust allows for the control of the company to remain with the owners; helping smooth the transition of ownership to the company’s employees for the purpose of business exit.  

By the company’s employees owning shares in the company, the company may not trigger capital gains tax by selling the company shares to its employees.  

Employees ultimately pay capital gains tax when they sell their shares back to the company, either at fair market value, or a discounted rate, depending on the circumstances of their leave.

Why are ESOPs popularly discouraged and are ESOPs a good idea?

The common statement you will read online is that ‘ESOPs are complicated and generally not worth the risk’. In terms of fulfilling a higher and more secure retirement savings, people will usually stick to the sure-fire method of contributing to their superannuation fund. There are legal procedures and taxes which accompany the selling-off of shares or stock, which discourage most employees at the outset of accepting an ESOP.  

Is your company the right fit for an ESOP?

Employee ownership is a sufficiently strong model, however, not all companies have an appropriate fit for ESOPs. Start-ups and small firms are unpredictable and less advised to create ESOPs, despite the law becoming increasingly favorable for them.  

Situations where too many employees leave and force-sell their shares back to the company can put the company in debt, decreasing the overall value of the shares. Equally, owners can lose too great a shareholding by offering too many share options. Company owners must therefore decide whether there is any value to creating an ESOP.  

If one-by-one, employees begin withdrawing their share value from the company and leaving, the company will lose both human talent and morale and will deplete the reaming pool of employees to buy back the sold-off shares of the company, leaving owners with debt.  

Leveraged ESOPs stand to gain and lose the most; owners can be faced with the debt of buying back lost shares, as well as the debt from originally issuing those shares in the event they lose employees. Therefore, ESOPs are risky when the unity of the company and its employees are uncertain, or when the company’s future is uncertain, like with some start-ups and small businesses.  

When are ESOPs beneficial?

So, when are ESOPs a good idea? When the company is well managed and committed to keeping its employees, and when it has a greater number of employees who are committed to the company in return.  

Also, when companies can enter an employee ownership model having already received financing (without leverage), they can expect to perform better against these losses. Ultimately, companies which are strong culturally and financially can extract the most value from ESOPs and their tax advantages.  

Employee Share Option Plans and the Future

Despite the risk that accompanies employee ownership, the future looks bright for business owners who use this ownership model.

The need for multiple people to keep a business growing

As is currently at the front of many business owners’ minds, the recession period following the economic effects post Covid-19 have devastated many small to medium-sized enterprises and their owners.

Many are unable to withstand the challenge of independently maintaining a business, hence the need for multiple people to be empowered to keep a business growing.  

Employees were driven to maintain their jobs and knew that being taxed on additional income would be a greater loss than deferring the tax and income until after, through an ESOP trust.  Also, since business owners must receive fair-market value for their company’s shares by nature of the accounting and sales structure of ESOPs, they would uniquely benefit during these times from selling their shares through an ESOP. 

The ESOP Structure in Australia

In Australia, the structure of ESOPs has become progressively in favor of employees and start-ups. Pre 1 July 2015, employees were required to pay tax upon immediate sale of the shares. Post 1 July 2015 that tax could only be applied at the moment the employee receives a reasonable profit from the sale of shares with respect to the tax amount.  

The change in law also allows employees to defer that tax for 15 years, and only after the employee exercises the share option as a share. This benefits the business owner also, since it incentivizes employees to keep their shares in the company for longer as there’s no personal expense for the employee in doing so. 

Grant Caps for Unlisted Companies 

In effect from 1 July 2022, the grant caps for unlisted companies have increased from $5,000 to $40,000, and non-staked grants are uncapped. This means companies will be able to stake more money in their company through employees, where they are required to buy into the share option plan. Unlisted companies can create larger rewards for their employees as well.  

As Australian small and medium business owners continue to navigate the current recession, they may increasingly seek employee ownership models with ESOPs for tax advantages and structure, which may provide great success for smaller, unlisted companies.   

How do I create an ESOP with my company?

For help with creating an ESOP in your company, simply get in touch with us below and we’ll get back to you within a day! Our team of experienced workplace lawyers can help ensure that your company meets the requirements for an ESOP and can advise you on implementation of an ESOP.

Need help creating an ESOP for your company?

Contact us by giving us a call on 1800 820 083 or request our advice today.

*NB// The contents of this article are information only and should not be relied on as legal advice. Please seek specialist legal advice in relation to your particular situation.

(c) Progressive Legal Pty Ltd – All legal rights reserved (2023)


How does an ESOP benefit employees?

An ESOP benefits employees by providing them with the opportunity to become partial owners of the company. This can lead to financial gains if the company’s share price increases.

Owning shares can also enhance job satisfaction and loyalty, as employees have a vested interest in the company’s performance.

What are the tax implications of participating in an ESOP?

The tax implications of participating in an ESOP can vary based on the specific plan and jurisdiction. Generally, employees may not have to pay taxes on the option grant.

However, they may need to pay taxes when they exercise the options and acquire the shares, as well as when they eventually sell the shares. We strongly advise consulting with a tax professional to understand individual tax obligations.

How is the exercise price of an ESOP determined?

The exercise price of an ESOP is typically set at the fair market value of the company’s shares at the time the options are granted.

This price is predetermined and remains fixed for the duration of the option period, allowing employees to purchase shares at this set price regardless of the market value at the time of exercise.


Let’s say a company grants ESOP options to its employees on January 1, 2024, when the fair market value of its shares is $10 per share.

The exercise price is set at $10 per share. Over the next few years, the company grows, and by January 1, 2027, the market value of its shares has increased to $20 per share.

Despite the increase in market value, employees who were granted ESOP options in 2024 can still exercise their options and purchase shares at the fixed exercise price of $10 per share.

If they choose to sell the shares at the current market price of $20 per share, they would realise a profit of $10 per share.

This predetermined exercise price allows employees to benefit from the company’s growth and the increase in its share value over time.

What happens to ESOP options if an employee leaves the company?

If an employee leaves the company, the treatment of their ESOP options will depend on the terms of the specific plan. In many cases, vested options can still be exercised within a certain period after leaving the company.

Unvested options, however, may be forfeited. It’s important for employees to review the terms of their ESOP agreement to understand what happens to their options upon departure.

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