Employee Stock Ownership Plan (ESOP)

Brent Watson
Brent Watson
What’s the difference between an employee stock purchase plan and an employee stock ownership plan? When should a company consider implementing one or the other? These are a few of the topics covered in this article.

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What Is an Employee Stock Ownership Plan (ESOP)?

An employee stock ownership plan (ESOP) is employer-provided company stock given to the employee during their employment. If the employee leaves the organization before the plan is fully vested, the stock is returned by selling it back to the ownership plan. By having stock, the employees’ overall compensation can be enhanced if the company performs well.

Stock ownership plans have been implemented and successful in both large and small organizations in a variety of industries. As of 2021, there were approximately 6,500 organizations operating with an employee stock ownership plan.

Employee Stock Ownership Plan Versus Employee Stock Purchase Plans

While employee stock ownership plans (ESOP) and employee stock purchase plans (ESPP) seem the same there are a few differences.

Obtaining Stock

With an ESOP, employees can be provided stocks in a few different ways. They can be granted stock after a pre-set time of employment or when they initially join the company. ESOPs can also be part of your organization’s retirement offering.

ESPPs are stock available to employees at a discounted rate. These can be purchased with an employee’s personal funds or through deductions of their payroll.

Stocks after Termination

Under an ESOP, the terminated employee has a few options. They can transfer it to a different retirement account, or withdraw the money and pay taxes on the gains. If the employee is under 59 ½, this would include an additional 10% fee for early withdrawal. If the stocks aren’t fully vested, these rights are forfeited back to the company.

With an ESPP, the terminated employee can keep the stock until they decide to sell it. Their former employer could purchase the stock back at current value rather than the discounted price.

The Benefits of Employee Stock Ownership Plans

There are many benefits to offer employees that also benefit the business. Here are three employer specific benefits of an ESOP.

  • Ownership. To borrow a lyric from the musical Hamilton, “When you got skin in the game, you stay in the game.” Owning stock in the company gives employees a personal interest in seeing their company succeed, which increases the return on their stocks and boosts compensation. When employees are also owners, there’s a higher chance of receiving discretionary effort.
  • Retention. All organizations are looking for top talent, and ESOPs tend to have higher retention of their employees than other types of organizations. This benefit can set the company apart from others by attracting highly talented applicants.
  • Financial. Adding stock to the ESOP or taking a loan against your ESOP can qualify as a tax-deductible expense. Employees could qualify for deductions as well. Keep in mind that it will be important to consult with a financial advisor for legal counsel for current tax laws as they do change.

When To Consider Offering An ESOP

Here are three situations when offering an ESOP is beneficial to a company.

Exit Strategy for Aging Owners

For a privately held company with a  founder approaching retirement, finding a trustworthy buyer can be a long process. By setting up an ESOP, there’s an instant market for the owner’s stock which can provide a financially successful and timely exit strategy.

Family Business

Family business owners often want to pass their business to their children. When their children are not interested, offering an ESOP provides an alternative to closing the business by handing the organization to the employees who have been with them over the years. These employees have captured the vision and can maintain the culture of the original founders.

Financial Loans

For some businesses, a benefit of the ESOP is that the organization can take out a loan to purchase the company stock. When repaying the loan, both the principal and the interest are tax-deductible. This can create additional funding for other aspects of the business.

Best Practices for Implementing an Employee Stock Ownership Plan

When considering becoming an ESOP, it’s important to implement the changes well. Here are three practices to get off to a great start.

Strategy

Before implementing an ESOP, it is important to identify with the leadership team how to accomplish the overall company business strategy to ensure an ESOP will help accomplish company goals. A strong return on investment will propel the organization into future success.

Analysis

After identifying that an ESOP fits into the company strategy, a financial analysis can ensure that the business will operate profitably after the change. A financial advisor or financial officer is an important player during this transition. Being aware of and addressing potential problems before the change is implemented will guarantee the greatest success.

Communication

Employees will need to be prepared before implementing an ESOP. Since they will become “owners” of the company, they will need to be informed of their additional responsibility and rights. Some of the employees may never have been in this type of leadership structure and good communication can ensure that they are equipped with the right tools and resources. By investing the time in preparation, the company can be set up for success.

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Questions You’ve Asked Us About Employee Stock Ownership Plans

Are there any drawbacks to employee stock ownership plans?
The short answer is that it depends. ESOPs have implications on how company decisions are made and financial resources for the company and employees.
Who is eligible to participate in an ESOP?
It depends on how the ESOP is set up. All employees over the age of 21 are legally able to participate if the benefits are expanded to the organization. Some ESOPs are included in an organization’s compensation strategy for senior leaders.
Brent Watson
Brent Watson

Brent Watson enjoys problem solving, analyzing data, team building, and becoming an HR Guru. His work experience comes from the employee experience, recruiting, and training arenas. After attending a local HR conference, Brent knew that he had found his people and the problems he wanted to solve for in the business world.

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