EMPLOYEE STOCK OPTION

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EMPLOYEE STOCK OWNERSHIP PLAN

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An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock.

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What Is an Employee Stock Ownership Plan (ESOP)?

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An Employee Stock Ownership Plan (ESOP) gives the sponsoring company—the selling?shareholder—and participants various tax benefits. It's a?qualified retirement plan. Employers often use them as a?corporate finance?strategy to align the interests of their?employees with those of their?shareholders.

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An ESOP is usually formed to facilitate succession planning in a closely held company by allowing employees the opportunity to buy shares of the corporate?stock. ESOPs are also offered as a?retirement?benefit.

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How Does an Employee Stock Ownership Plan (ESOP) Work?

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ESOPs are set up as?trust funds. They can be funded by companies putting newly-issued shares in them, by putting cash in to buy existing company shares, or by borrowing money through the entity to buy company shares. ESOPs are used by companies of all sizes, including several large, publicly traded corporations.

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Companies with an ESOP must not discriminate and are required to appoint a trustee to act as the plan?fiduciary.

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Advantages of ESOPs

Since ESOP shares are part of the employee’s?remuneration?package, companies can use?ESOPs?to keep plan participants focused on corporate performance and share price appreciation. Employees, meanwhile, are presented with a way to make more money, increase their compensation, and essentially be rewarded for their hard work and commitment.

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ESOP Up-Front Costs and Distributions

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Companies often provide employees with such ownership with no up-front costs. The company may hold the provided shares in a trust for safety and growth until the employee retires or parts ways with the company.

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Companies typically tie distributions from the plan to?vesting, which gives employees rights to employer-provided assets over time. Typically, they earn an increasing proportion of shares for each year of their service.

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When a?fully-vested?employee retires or leaves the company, the firm “purchases” the vested shares back from them. The money goes to the employee?in a lump sum or equal periodic payments, depending on the plan.

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Once the company purchases the shares?and pays?the employee, the company redistributes or voids the shares. Employees who leave the company voluntarily?cannot take the shares of stock with them, only the cash payment.

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What Does ESOP Stand for?

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ESOP stands for employee stock ownership plan. An ESOP grants company stock to employees, often based on the duration of their employment. Typically, it is part of a compensation package, where shares will vest over a period of time. ESOPs are designed so that employees’ motivations and interests are aligned with those of the company’s shareholders. From a management perspective, ESOPs have certain tax advantages, along with incentivizing employees to focus on company performance.

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How Does an ESOP Work?

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First, an ESOP is set up as a trust fund. Here, companies may place newly-issued shares, borrow money to buy company shares, or fund the trust with cash to purchase company shares. Meanwhile, employees can accumulate a growing number of shares, an amount that can rise over time depending on their employment term.

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What Is an Example of an ESOP?

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Consider an employee who has worked at a large tech firm for five years. Under the company’s ESOP, they have the right to receive 20 shares after the first year, and 100 shares total after five years. When the employee retires, they will receive the share value in cash. Other types of stock ownership plans may be offered instead of an ESOP. They include stock options, restricted shares, and stock appreciation rights, among others.

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Are ESOPs Good for Employees?

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Yes, ESOPs can generally be considered a benefit for workers. These programs tend to be adopted by companies that don’t change staff frequently. They often result in a bigger payout for employees.

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The Bottom Line

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ESOPs are generally a win-win for employers and employees, encouraging greater effort and commitment in exchange for bigger financial rewards.

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Not all ESOPs are the same. Rules on actions such as vesting and withdrawals can vary. It’s important to be aware of them to make the most of this benefit and not potentially miss out on an extra bonus.

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