Are there any problems with ESOP?

Imagine you are an employee-owner of the company you work for, and one-day circumstances lead you to sell the firm to another; what are the possible series of incidents that can happen now? The company may lay off some of its employees, there will not be any more holdings in the company decisions, and worst of all, every company policy will now go through changes. But imagine you are selling the shares of your company to your ESOP. This way, you can retain your employees, enjoy taxation benefits and get the market price for your shares.?

Employee Stock Ownership Plan (ESOP) is a scheme where the workforce can exercise their rights over their allotted company shares. The system helps employees and employers have a mutually beneficial relationship with each other. The employers get to hold the talented employees to themselves, and the employees feel a sense of ownership which further encourages them to improve their productivity. According to a GAO study, companies with ESOPs have been found to have a 52% increase in productivity. Also, the employees in such firms have reported at least 92% enhanced household wealth.

There are 22000 companies offering ESOP benefits to their employees in the US. You can see leaders, managers, and workers all on the same team working in unison to promote and fulfill company goals in an ESOP setup. The incentivization of top talents will also lead to the expansion of your pool size. In the era of layoffs and frequent instability of jobs, ESOPs offer more reasons to establish commitment between a company and its employees. However, the road to an ESOP journey can sometimes have pits and falls. In this article, we will discover a few problems associated with ESOP setup, not to urge you to give up the scheme but for you to make informed decisions regarding the same.

Potential problems for the employers

• Raising capital for an ESOP company is a challenging task. You need agents with financial expertise to guide you in setting up the capital framework with advanced accounting knowledge.
• The cost to establish an employee-owned company is expensive. You need at least $80,000 to $250,000 to start an ESOP scheme in your company in the first year of incorporation and then $20,000 to $30,000 yearly. It is certainly not a possibility for small companies.
• It is a general idea that younger employees are more focused on immediate gratification and are the least concerned about retirement benefits. In such cases, an employee leaving early puts the company in place to purchase his shares at the market rate. This in turn can have a bad impression on the firm's cash flow and balance sheet.
• An ESOP may increase loyalty but is still insufficient to increase overall employee morale. Since the data and asset information of the company is transparent, they can sometimes be misused.

The ESOP legend in the 80s, Weirton Steel, US had to confront bankruptcy in 2003 where the stacks of employees were worth nothing. Moreover, they could only preserve 2,000 of their 8,000 employees during the transition. The main contributor to the ESOP failure was the lack of democracy and poor financial management.

Potential problems for the employees

• In cases like the above with a bankruptcy issue, most senior employees who have put in huge amounts as an investment so far can be broken by the end of dissolution.
• In an employee-owned firm, there can be any number of managers, and all of their objectives and purposes may not align. This can cause internal disputes that might demand attention.
• One of the most discussed drawbacks of an ESOP culture is the need for more clarity in succession. If a manager is to leave the company now, there must be enough resources to replace him without a mess. But with equal ownership for everyone, it can be a difficult task to manage succession.
• You may need more visibility in the company decisions concerning more such employee ownership.
• The capital cash flow will fluctuate because of the company's need to purchase new shares and borrow new debts now and then.

United Airlines' establishment of ESOP faced a huge failure because of the low representation of employee voices in framing crucial company policies and strategies. Apart from the ownership of shares, there was no opportunity for the employee-owners to have a say in the financial decisions. The financial illiteracy contributed to the overall failure of the company.

Summing up

There are certainly a few issues that must be kept in mind before you set up an ESOP plan, but all the reasons together cannot nullify the fact that employee ownership can promote the much-needed credibility and management to run a business operation smoothly. Focusing on what type of schemes can meet the expectations of the employees and what backup plans a company needs to establish if the ESOP is not working in their favor, a perfect beneficial scheme can be laid out. You might want the assistance of an expert in the exhaustive process. This is where Eqvista comes into the picture. All you need to do is set up a free consultation call, and we can help you make the best choices for your company.