The fabled benefits of ESOPs

It is widely accepted that companies which involve their employees in share ownership receive benefits through the recruitment and retention of staff, the fostering of employee interest in the company and the motivation of employees to improve profits. In addition, institutional investors generally prefer to see senior executives benefit by shares rather than cash.

An Employee Share Ownership Plan (ESOP) offers a flexible vehicle through which to provide share incentives to employees.

Essentially, it is a discretionary trust, often established offshore. The trustees are empowered to acquire shares in the market and distribute them directly to beneficiaries or through an approved profit sharing scheme, save as you earn option scheme or discretionary share option scheme. Shares are often held or "warehoused" by the trustee before being distributed.

There are two types of ESOP used in the UK - "common law" ESOPs and statutory ESOPs, both of which involve the creation of a discretionary trust. (The expression "common law" in this article is used in the English law sense and has no strict meaning in Guernsey because the jurisdiction now has a codified legal framework for trusts.)

Establishing a common law ESOP offshore with a non-UK, perhaps Guernsey, resident trustee to manage the trust offers significant advantages as the trustee is outside the scope of the charge to UK capital gains tax and is not obliged to file an income tax return in the UK in respect of trust income.

The cost of an offshore ESOP, therefore, compares favourably with an onshore arrangement.

Importantly, the Guernsey resident trustee will not be carrying on a business in the UK and so will not be subject to the Financial Services Act.

In the case of a multinational company an offshore ESOP offers a single centre from which shares can be allocated by the trustee to schemes or employees in various jurisdictions.

The discretionary trust comprising the ESOP is funded either by the employing company by way of a loan on favourable terms, or by a third-party loan guaranteed by the employing company.

An ESOP can be established for either a listed or unlisted company. It provides a particular advantage for the latter because the trust can buy shares from employees who wish to sell.

An ESOP offers protection to existing shareholders from dilution as shares are purchased in the market. By contrast, conventional share schemes involve new issues, often at a discount to market value.

Companies should consider establishing an ESOP, particularly as employee share schemes established in the mid-1980s are due for renewal and issues such as the marketability of shares and flexibility of benefits are being reconsidered.