ESOP is an essential idea for a private company’s employees to grow their wealth with company share value. Now the companies are becoming more aware of the employee’s well-being by providing them incentives for their overtime, an increased number of holidays, and yearly trips to an exotic location. They also started to provide more benefits to the employees other than their competitive salaries in the form of an ESOP, which stands for Employee Stock Ownership Plan, as a part of an employee benefit plan that allows the employees to acquire ownership interests in their organisation.
Employee stock ownership plans are given as direct stock, profit sharing plans, and bonuses that can be obtained by the employee in any way. The cost of creating and maintaining such plans depends on the size and complexity of the plans. There are various factors involved in the initial cost of ESOP in India, such as legal fees, accounting fees, and administrative expenditures. ESOPs are considered a way to motivate and foster a sense of participation among the talented employees to work towards the company’s growth and success by providing them with such financial benefits.
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How does an Employee Stock Ownership Plan (ESOP) work?
Firstly, the number of shares that are considered viable for the ESOPs, their price, and the beneficiary employees are decided by the employers and given to the employees at a specific date. After they are granted to the respective employees, they remain in a trust fund for a specific amount of time known as the vesting period. Employees can only take advantage of the ownership of stock offered through ESOPs as long as they decide to work with the organisation.
Once the vesting date arrives, on which the employee’s vesting period expires, provide rights to the employee to exercise their ESOPs. Employees have both options that allow them to buy company shares at a lower price than the current market price and to sell their shares that they have acquired through ESOPs to gain profit from their holdings. However, there is one important condition in the case of ESOPs that requires the company to buy back the ESOPs at an acceptable market value within the period of 60 days after the employee leaves or retires from the organisation.
Some important considerations to be kept in mind while implementing ESOPs in an organisation
- The company should have a long-term record of profitability and doesn’t have huge amount of debt as compared to its equity. In case of taking loans, it should have a good relationship with its lender.
- The management team of the company should have many years of experience in the field and known to be trustworthy by other professionals in the area.
- The company should be able to bear the cost of initial setup and maintenance. It is also considered best for the companies to create ESOPs for their 20 employees only.
What are the main advantages of ESOPs for the employees and employers in the organisation?
- It can help employees in their retirement plans as it allows them to generate wealth over time because of the growing value of private company stocks at a fair market rate.
- ESOPs also offer them tax benefits, as they are not required to pay taxes on the value of their shares until they are distributed at the time of retirement.
- It also provides employees with a sense of security and makes them less likely to be worried about getting laid off during times of economic crisis.
- It is also shown by various studies that companies that are known to provide ESOPs to their employees also give them better benefit packages, which in turn leads to a higher number of productive, engaged, and motivated employees who want to contribute towards the company’s growth and success.
- It helps to lessen the tax burden on employers by reducing their contribution towards ESOPs, which saves them from selling their shares to an outside buyer.
- ESOPs are also an efficient way of increasing the company’s profits and serve as a reliable source of financing for the company.
- It follows a flexible structure that allows them to be made in such a way to meet the needs and predetermined goals of the organisation.
How are ESOP allocated to the employees?
- Contribution based allocation: The company decides to purchase stock by contributing a certain amount of its stock or cash by considering a percentage of its employee’s eligible compensation.
- Age/Service based allocation: Employee’s are considered eligible for the ESOPs on the basis of their age, length of service or a combination of the two factors. Older employees with more seniority are given more preference to receive large share allocations.
- Hybrid Allocation: Allocations of shares are made on the basis of both compensation and service time to ensure rewarding long-term employees and retaining them in the company.
- New hire allocation: Some ESOPs also provide a set number of shares to the newly hired employees to easily find talented employees and make them feel that they are the owners of the company from the starting of their joining date.
Conclusion
Employee stock ownership plans can be used as a powerful tool by companies to expand their business and increase the reach of their customers by promoting them on various platforms with the help of their talented and experienced employees. ESOP can also help employees maintain a stable income in the long run and associate themselves with the company that encourages them to improve their skill set, provides them with additional benefits, and provides them with job security. ESOPs allow employees to retain ownership of shares in their companies through various means, such as direct stock, profit sharing plans, and bonuses.
There can be various ways in which ESOPs can be allocated to employees on the basis of compensation, age, or level of seniority, a combination of these factors, or newly hired employees. The ESOPs also provide the greatest advantage to employees, as they can buy and sell shares according to their own needs. The most important condition of ESOPs is that they require the company to buy them back at a fair market rate during the 60-day period after the employee decides to leave the company and is expected to retire from his job.