10 things to consider before implementing ESOPs in South Africa

In South Africa, over half a million employees participate in Employee Share Ownership Plans (ESOPs).  ESOPs are playing an increasing role in promoting employee ownership and economic inclusion.  Employee ownership can align shareholder and employee interests, enhance employee engagement, and improve business performance.  An ESOP can also help companies meet Broad-based Black Economic Empowerment (B-BBEE) goals.

Comprehensive ESOP planning is crucial in order to achieve sustainable ESOP success. Here’s what you need to consider before getting started:

1. Clear objectives

Before implementing an ESOP, define your key goals. Are you aiming to improve employee engagement, drive better alignment between certain employees and shareholders, or perhaps enhance B-BBEE ownership? Understanding your key objectives is essential for structuring a successful employee ownership scheme.

2. Optimal ESOP benefit structure

There are various types of ESOPs, ranging from simple to complex. Evaluate the different structures available and choose an ESOP benefit structure that aligns with your business’s goals and circumstances. For example, you may decide between actual share ownership for employees or a trust where employees are beneficiaries. Or a dividend participation scheme vs a capital appreciation scheme.  The structure must take into account what the primary objectives are and then make sense from both a business and employee standpoint.

3. Compliance with B-BBEE Codes

Ensure that the ESOP is structured in compliance with the ESOP requirements of Code 100 of the B-BBEE Codes of Good Practice. The Codes set out minimum requirements for governance of the scheme, the board of trustees, and beneficiary identification and communication.

4. Funding structure

Most ESOPs require funding, which is often provided by the company as vendor financing. This can be interest-bearing and secured by the ESOP shareholding, and dividends may be used to repay loans. While loans may be used, other funding approaches like preference shares and notional vendor financing may be preferable.  A clear funding strategy is key to ensure the sustainability of the ESOP as well as related B-BBEE success.

5. Taxation implications

The tax treatment of ESOPs can be complex, and it’s important to understand both the company and employee perspectives. While the government supports ESOPs, companies typically don’t receive tax deductibility, and employee payouts are often fully taxable. Businesses need to manage the timing of receipts and distributions carefully to avoid adverse tax implications.

6. Accounting and financial reporting

Be clear on the expected International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Principles (GAAP) accounting treatment for the ESOP, as relevant.  The recognition and measurement of the ESOP shares and any related expenses or liabilities can vary greatly depending on the targeted ESOP structure.

7. Alignment with remuneration and reward policies

Ensure that the ESOP aligns with the company’s overall remuneration and reward policies, including any other equity-based compensation plans. This includes determining the appropriate balance between the ESOP and other incentive programs, as well as considering the impact of the ESOP on the company’s overall compensation structure and philosophy. This is particularly relevant for management incentive schemes.

8. Compliance with listing rules

A listed company must also comply with the listing requirements of the exchange on which it is listed when implementing an ESOP.

9. Employee communication

Clear communication with employees is critical to the success of any ESOP. This includes explaining the scheme rules, improving financial literacy, and managing expectations about business performance and payouts. Proper training can also build trust and achieve employee buy-in.

10. Trustee training

The success of an ESOP also depends on the trustees who manage it. Ensuring that they understand their roles, fiduciary duties, and the workings of the ESOP is essential. Comprehensive training will help them fulfil their responsibilities effectively.

ESOPs involve complex financial, legal, regulatory and operational considerations. When designed and implemented well, employee ownership can enhance employee engagement, retention, and company performance, as well as secure stronger B-BBEE compliance. Consulting experienced ESOP advisors will help maximise the benefits of an ESOP for both your company and its employees.

About the Authors

About Shaun Smit CA(SA), MBA – Director at Transcend Capital

With over a decade of experience in providing Employee Share Ownership Plans (ESOP) and BEE transaction advisory to multinationals and South African corporates, Shaun Smit has a proven track record in crafting and executing ownership strategies aimed at fostering growth and sustained business success.  Shaun believes that employee ownership can be a powerful tool for increasing engagement, improving business performance, and achieving meaningful broad-based empowerment. Outside of work, Shaun is a dad-taxi and enjoys running and playing tennis.

About Bruce Hunt BCom, CFA, MBA(Manchester) – Director at Transcend Capital

Bruce is the Managing Director at Transcend Capital. He has 12 years of experience in structuring multinational BEE transactions which include Black operational partners, employees, Broad-based Ownership Schemes, and the sale of assets to Black investors. Before joining Transcend Capital, Bruce was a trader and structured finance professional at Investec Bank.