The 7 FAQs from Employers About ESOPs

EMPLOYEE STOCK OWNERSHIP PLAN

FAQ #1

What is the purpose of an ESOP for my company?

There are various reasons why you, as an employer, would explore an ESOP plan, but in our experience the main purposes behind a decently structured ESOP plan is to either save a company from bankruptcy by raising its value, bring in new owners when the current ones want to exit, or give existing employees a chance to own a piece of the company and use it as a part of your total reward strategy.


FAQ #2

How is an ESOP plan different to a retirement plan?

Fundamentally, ESOPs are retirement plans and are required to follow all the basic rules for tax qualification and non-discrimination that other retirement plans must adhere to. But where they differ is in some of the rules they must follow, including specific distribution rules, as well as in the advantages in store for employees. These benefits include the ability to make higher annual contributions to an ESOP than to other plans and the potential to receive significant dividends on the stock.


Additionally, a particularly well-designed ESOP has the power to unlock tax benefits that are leaps and bounds ahead of those delivered by a 401(k).

FAQ #3

How would an ESOP benefit my company?

Let’s start with the fact that according to the Department of Labor, companies with an ESOP tend to outperform those without – and not just in market value, but in terms of ROA and ROE. The study also indicated that ESOP companies boast lower turnover rates.


This is mostly because an ESOP creates a culture of ownership, where employees feel like partners. As such, these employees are more likely to be loyal, more likely to place a higher value on their performance and as such, work harder to ensure future success.


Another benefit that shouldn’t be overlooked is the way that you can use an ESOP to preserve your legacy by handing your company over to a trusted management team who have a vested interest in the company’s survival.



FAQ #4

What types of ESOP plans are there?

There are various types of ESOPs, but the most common in our experience include the popular Employee Stock Option Scheme (ESOS), the Employees Stock Purchase Plan (ESPP), the Restricted Stock Unit (RSU), and Phantom Stocks.


Here is a brief look at each:

ESOS

Employees can own company stock as a right (not as an obligation) by buying company shares at a lower price than the current market value. The option is subject to vesting, meaning that it can’t be claimed until employees are fully vested.

ESPP

Employees are allotted a certain number of shares in the company at a discount to the stock’s Fair Market Value (FMV) and are required to hold onto their shares for a set period of time after purchase.

RSU

Employees receive shares upon the completion of certain conditions, either as part of a specific company or total reward strategy employee performance.

Phantom Stocks

Employees receive shares in the company without the actual transfer of the stock itself in an effort to align employees with owners, letting them reap the same benefits without having to give up equity in the company.

FAQ #5

Can an ESOP lose value?

The short answer is that yes, an ESOP can lose value. However, it can also increase in value. It all depends on how the company is performing in the market, so when your company’s performance drops, the ESOP’s value will decrease or shares will be taken away to pay debts.

FAQ #6

Do ESOP companies pay taxes?

This is a bit of a layered answer. Yes, every company is entitled to federal taxes however, ESOP shareholders are exempted from such tax. If a company pays income taxes on its profits, it still owes those same taxes to its state and federal governments.

FAQ #7

Are ESOP plans risky?

We spoke previously about how ESOPs are widely misunderstood for a number of reasons, but perhaps one of the biggest misconceptions is that ESOPs are a huge risk. There’s a certain amount of risk in all business ventures and strategies, however we have found that when an ESOP plan is informed and structured by experts, like the lawyers, consultants, and investment bankers that we rely on to guide our clients through this process, the risk is mitigated. Not to mention the many protections in the law which prevent an ESOP from being too risky.

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