Employee Stock Ownership Plan: (Esop) Made Simple

Employee stock ownership plan (ESOP) is a workforce benefit program that provides employees ownership interests, issued as direct stock shares in an organization. ESOPs are offered by organizations mainly with an objective to attract, compensate and retain employees.

employee stock ownership plan

How Employee Stock Ownership Plans (ESOP) Work?

Employee stock ownership plans are retirement plans in which organizations allocate certain shares of stock as compensation or incentives to employees often as the part of employees remuneration scheme. The shares of stock vests over a period of time before an employee is entitled to them. With employee stock ownership plan an employee never buys or hold the shares of stock directly making these programs are a contribution to employees, not employees purchase. These stocks are distributed to beneficiary account only when the employee retires, becomes disabled, dies or chooses to leave the company. The shares are usually bought back by the company for redistribution.

Employee stock ownership plans are usually set up as corporate trusts to raise investment and capital for companies and to facilitate succession planning in closely held organizations. When a major shareholder chooses to leave the business the company could be left devastated. In such situations, ESOPs offers better transitional flexibility to facilitate the company's succession planning. These programs are commonly structured to provide a market for shares of departing shareholders and to raise fundings for acquiring new assets in pretax.

Employee stock ownership plans are aimed at improving the overall functioning and performance of the company and increasing the value of the stocks by involving shareholders. The employee stock ownership plans help in minimizing problems related to employees acquisition and retention. The major objective of such programs is to compensate, attract and increase employees representation at broader levels. These plans are often provided at no upfront costs.

For an employee to qualify for ESOPs he/she must be at least 21 years of age and have completed 1,000 hours of service within a set calendar year. Employers (owners) usually funds the ESOPs trusts with shares of their own preexisting stocks that have been appraised for certain value in the market but are also likely to make cash contributions, that are substantially used to fund the repurchase of shares when the employee resigns or retires.

The remuneration earned by the employee after the buyback of the stocks from the host company is transferred in a lump sum or equal periodic payments but limited to a maximum period of 5 years, as per the conditions agreed on. The shares are then again added to employee stock ownership plan trust for redistribution. Employees entitled to vested stocks are required to sell back these shares to the company when they retire or resign.

Organisations that are majority employee-owned initiates employee stock ownership plans. Unlike workers cooperative the control of such organizations is not evenly distributed. The voting rights are limited to a set of major stakeholders.

Employee Stock Ownership Plan: Distribution

Employees under employee stock ownership plans are entitled to stock distribution based on:

  • Retirement: Employees that have leveled their job by reaching the retirement age or have applied early.
  • Disability or Death: Under such circumstances the shares are allocated to the benificiary with respect to terms agreed upon.
  • Termination: Employees terminated for miscellaneous behavior are distributed shares that they are entitled to but are excluded from any additional plan benefits.
  • Resign: Employees that chooses to resign are only entitled to shares upon reaching the maturity period. Early withdrawals are subjected to penalties.

Employee stock ownership plan and Other Forms of Employee Ownership

ESOPs are based on employee ownership principle and provides several tax benefits including tax-deferred growth and deductible contributions. Other forms of employee ownership plans include direct-purchase programs and stock options.

Direct purchase plans

Direct purchase plans allow employees to buy shares in the company with their own investable assets. This provides employees an opportunity to purchase company stocks at a discounted price.

Stock options

Stock options is a compensation contract between an employer and an employee that carries potential characteristics of financial options. This allows the employee to buy a set of shares at a price fixed on grant.

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