Employee Stock Ownership Plan (ESOP) is a type of employee benefit plan and a system under which the employees of a company are generally given the right to acquire the shares of the company for which they are working.
Under the scheme, the employees are granted some rights, called as stock options, to get the shares of the company at a concessional rate and, at a predetermined price. ESOP help in minimizing problems related to incentives.
Under the ESOP, facility of owning some shares of the company is made available only to senior executives called ‘Selective Plan’ and the other side when the facility of owning some shares of the company is made available to all employees of the company called ‘All Employee Plans’.
How does an ESOP work?
The ESOP operates through a trust, set up by the company and it allows ESOP to its employees for buying a specified number of shares of the company at a mentioned price after a certain number of years.
An employee needs to go via the pre-specified lay period Before an employee could exercise his option which implies that the employee has to work for the organization until the entire stock options could be exercised.
- Capital Appreciation: Companies are selling some equity to the employees and the process converts corporate taxes into tax-free capital appreciation.
- Incentive: With the help of ESOP, Company motivates its employees by provides a cost-effective plan that helps employees in their future uncertainties.
- Tax Benefit: An owner of a company can sells all or some of the company to the employees cost-free. Owners who sell some proportionate of their company to an ESOP are allowed to “roll-over” the proceeds into other securities and defer taxation on the gain.
- Reduces Tax Liability: By issuing treasury stock or newly issued stock to its ESOP, a company can reduce its corporate income taxes and increase its cash flow and net worth.
- Liquidity: If the value of the stock appreciates significantly, thus the ESOP and the company may not have sufficient funds to repurchase stock, upon employee’s retirement.
- Performance of Stock. If the value of the company doesn’t increase, in the situation the employees may feel that the ESOP is less attractive than a profit-sharing plan.
- Fiduciary Liability. Members who administer the plan are deemed to be fiduciaries, and if they knowingly participate in improper transactions can be held liable.