Looking for short, straightforward answers about ESOPs? Here are nine of the most common questions and answers about ESOPs. Take a look and let us know how else we can help.
What is an ESOP?
An ESOP, or Employee Stock Ownership Plan, is an employee benefit that enables employees to become owners of their company’s stock. When employees have a stake in their company, we find that it increases motivation, boosts job satisfaction, and leads to better financial outcomes for both the organization and the employee owner.
How do ESOPs work?
The company establishes a trust fund and contributes new shares of its stock, or cash to buy existing shares, to the fund. Employees then receive share allocations annually, typically based on criteria such as the employee’s compensation, service time, or other considerations. Employees receive access to their shares upon retirement or once they leave the job.
What are the tax advantages of ESOPs for companies and employees?
For companies, contributions to an ESOP are generally tax-deductible. Employees are not taxed on the contributions or their gains until they receive a distribution from the plan. Additionally, if the employee rolls over the distribution into an IRA or other qualified retirement plan, the taxes can be deferred further.
What is the difference between an ESOP and a stock option plan?
The two plans can get confused but there are key differences. Through an ESOP, employee owners receive an allocation of shares in the company. Alternately, in a stock option plan, employees are granted the right to buy shares at a specified price in the future. Stock option plans do not provide immediate ownership or any tax benefits until they are exercised and converted into actual shares.
How do employees access their ESOP shares?
After a vesting period – usually anywhere from three to six years – employees receive full credit for the ESOP shares in their account. Upon leaving the company, becoming unable to work, or retiring, employee owners can access their vested shares, which are typically distributed in the form of cash or company stock.
Can all companies establish an ESOP?
No. Closely-held, private companies best fit the profile to use an ESOP, as it can be a great option for succession planning. However, any for-profit corporation – private or public – can establish an ESOP. Partnerships, sole proprietorships, and certain professional corporations cannot have an ESOP.
How does an ESOP affect company control?
Management and governance of companies with an ESOP are similar to other companies. Although employees become shareholders through an ESOP, actual voting rights are typically exercised by the ESOP trustee. Employees may have limited or no voting rights, meaning control over major decisions remains with the company’s board of directors and executives.
Are there any costs associated with setting up and maintaining an ESOP?
Yes. They include legal, valuation, and trustee fee costs. These costs, however, can be offset by potential tax benefits, increased employee productivity, and enhanced talent attraction and retention.
Are there any risks associated with ESOPs?
ESOPs can pose risks such as insufficient diversification, as employees may have a significant portion of their retirement savings tied to the company’s stock performance. Additionally, economic downturns or poor company performance can negatively impact the value of the ESOP. However, these risks can be mitigated through proper plan design, diversification options, and effective management. Joining an ESOP holding company (like Empowered Ventures) can help reduce these risks.
Are you wondering if an ESOP could be right for the future of your company? Reach out to Empowered Ventures.
