An employee stock ownership plan (ESOP) is a way in which employees of a company can own a share of the company they work for. There are different ways in which employees can receive stocks and shares of their company. Employees can receive them as a bonus, buy them directly from the company, or receive them through an ESOP.
In the United States, ESOPs are a very common form of employee ownership. They have been growing in strength since about 1974. Around 11,000 companies have an ESOP in place, and nearly 8 million employees are involved in them.
Companies may establish an ESOP for a number of purposes. Most press attention regarding the use of ESOPs focuses on their use as a takeover defense or as buyouts of failing companies. These account for a very small percentage of ESOPs.
The main purpose of an ESOP is to reward and motivate employees. They are also used to provide a market for departing owners of successful companies. In most cases, an ESOP is given to an employee, rather than purchased by an employee.
An ESOP is similar to a profit-sharing plan. A company sets up a trust fund, into which it contributes either new shares of its own stocks or cash to buy existing shares. Another version of the ESOP borrows money in order to buy existing or new shares. In this case, the company makes cash contributions to the plan in order to repay the loan.
Company contributions to the plan are tax deductible. Shares in the trust are generally allocated to individual employee accounts. All employees over the age of 21 can participate in the plan, and senior members of the workforce acquire an increasing right to the shares in their account. This is known as vesting, and employees should be fully vested within five to seven years. Other employee’s shares are based on relative pay or some other equitable formula.
When employees leave the company, they receives their share options, and the company must be able to buy back these options. They must buy them back at their full market value. In private companies, employees are able to vote their shares on major issues such as relocation or closure. In public companies, employees can vote on all issues.
There are a few drawbacks to this plan. The cost of setting up an ESOP is around 30,000 US dollars (USD) for even the simplest of plans. When any new shares are issued, the stock of existing employees will become diluted. This dilution will be measured against the motivation and tax benefits of the ESOP. Also, private companies must buy back departing employees' shares, and this can become a major expense.