ESOP (Employee Stock Ownership Plan) Facts

Employee Stock Option Plans (ESOPs) motivate startup employees by aligning their incentives with the growth of the business. This guide covers options plans, how much equity to offer, creating terms, and long-term strategies.

Vesting refers to the employee gaining ownership over the options, and vesting motivates the worker to stay with the firm until the options vest. First and foremost, federal laws accord significant tax breaks to such plans. There is not any research on how employees react to options, although there is a great deal of anecdotalevidence that options do motivate people.

Major Uses of ESOPs

What is an 'Employee Stock Option - ESO' An employee stock option that grants specified employees of a company the right to buy a certain amount of company shares at a predetermined price for a.

These bonuses equate to the value of a particular number of shares. Stock appreciation rights give employees the right to raise the value of an assigned number of shares. Companies usually pay these shares in cash. An employee trust is a fund that an employer establishes on behalf Withdrawal benefits refer to the rights of employees with retirement Stock option plans are among the ways employers can compensate employees.

Here's how they work. Employee stock options are a form of equity compensation granted by companies to their employees and executives. The more that employees know about their employee k plans, the better. But what doesn't your administrator know? Ikea just announced it will offer its 13, salaried and hourly employees in the U. Here are the other companies that offer the best benefits around. These plans aren't widely used, but they fill a specific niche for employees in certain situations.

Here are some savvy strategies even the smallest business can use. Vesting is an important part of your company's retirement or pension plan. Almost unknown until , ESOPs are now widespread; as of the most recent data, 6, plans exist, covering Companies can use ESOPs for a variety of purposes. Contrary to the impression one can get from media accounts, ESOPs are almost never used to save troubled companies—only at most a handful of such plans are set up each year.

Instead, ESOPs are most commonly used to provide a market for the shares of departing owners of successful closely held companies, to motivate and reward employees, or to take advantage of incentives to borrow money for acquiring new assets in pretax dollars. In almost every case, ESOPs are a contribution to the employee, not an employee purchase.

In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan.

Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits. In other words, starting in , businesses will subtract depreciation and amortization from their earnings before calculating their maximum deductible interest payments. New leveraged ESOPs where the company borrows an amount that is large relative to its EBITDA may find that their deductible expenses will be lower and, therefore, their taxable income may be higher under this change.

Shares in the trust are allocated to individual employee accounts. Although there are some exceptions, generally all full-time employees over 21 participate in the plan. Allocations are made either on the basis of relative pay or some more equal formula. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting.

When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value unless there is a public market for the shares.

Private companies must have an annual outside valuation to determine the price of their shares. In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights such as for the board of directors on other issues. In public companies, employees must be able to vote all issues. Owners of privately held companies can use an ESOP to create a ready market for their shares.

Under this approach, the company can make tax-deductible cash contributions to the ESOP to buy out an owner's shares, or it can have the ESOP borrow money to buy the shares see below. To borrow money at a lower after-tax cost: ESOPs are unique among benefit plans in their ability to borrow money. The ESOP borrows cash, which it uses to buy company shares or shares of existing owners.

The company then makes tax-deductible contributions to the ESOP to repay the loan, meaning both principal and interest are deductible. To create an additional employee benefit: Or a company can contribute cash, buying shares from existing public or private owners. Rather than matching employee savings with cash, the company will match them with stock from an ESOP, often at a higher matching level. Contributions of stock are tax-deductible: That means companies can get a current cash flow advantage by issuing new shares or treasury shares to the ESOP, albeit this means existing owners will be diluted.

Cash contributions are deductible: A company can contribute cash on a discretionary basis year-to-year and take a tax deduction for it, whether the contribution is used to buy shares from current owners or to build up a cash reserve in the ESOP for future use.