Finance

Employee Stock Ownership Plan (ESOP)

Employee Stock Ownership Plan (ESOP)

Usually, companies try to keep a good relationship with their employees. To keep the employees motivated and making them feel like a part of the company, they offer Employee Stock Ownership Plans (ESOP) to the employees. These initiatives are aimed at enhancing the efficiency of the company and increase the worth of shares through the involvement in the company of shareholders who are also the employees. These programs are also used as a strategy to promote and retain high-quality employees. They were the herald of prosperous times in the 1990s, when a vast number of IT businesses allocated them to employees and allowed them to grow, making many of them millionaires.

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What Is Employee Stock Ownership Plan?

ESOP (Employee Stock Ownership Plan) refers to a defined contribution plan that provides employees with ownership interests in the company. They are issued as direct shares, profit-sharing plans, or incentives, and the company has the ultimate right to determine who should take advantage of these options. These plans are just like options that must be bought at a fixed price before the date of exercise. They are effective ways of inspiring employees and enhancing the distribution and development of markets for company shares. The shares are usually given at a lesser amount than the actual share price in the market.  This also helps the employee with their retirement plans as they get the amount once they retire. However, there are specified rules and regulations set out in the Company Rules that employers need to comply with, in order to grant the Employee share ownership plans to their employees.

How does ESOP work?

If a company decides to start ESOP first it has to build trust among their employee that the company has a good future. Then it has to decide whether it has to give out new shares that are not traded in the stock market to the employee or buy the existing shares from the stock market and allocate it to them. The shares are directly allotted to employees A/C on the basis of work experience and the no. of years the employee has worked with the company of the employee. New employees get access to the plan after a minimum of 1 year or the no. of days that the company has decided. Before an employee could exercise his option, he or she must go through a pre-defined vesting process, which requires that the employee must remain employed before part or more of the stock options can be exercised.

Advantages of ESOP:

There are various advantages of employee stock ownership plans:

  1. Tax Benefit: Employees get tax benefits on these plans as they do not have to pay tax for the dividend received but they have to pay the tax while selling the share.
  1. Employee Engagement: Due to the ESOP there is a good relationship between the company and the employee. The employee can see the future plans of the company and take part in decision-making processes.
  1. Positive Outcome: As employees get the feeling of the owner of the company they work hard for their company and the company gets a positive outcome.

Disadvantages of ESOP:

There are certain disadvantages as well:

  1. Lack of Diversification: As the employee has an optimistic view of their own company they are working in, they keep their portfolio focused on one company only and don’t diversify their portfolio hence if the company gets negative in future they will face huge losses.
  1. Restriction to the new employee: As the new employee cannot be part of the ESOP plan it can demotivate him and won’t work effectively for the company.
  1. Shares: As the company gives a certain amt of shares to its employee it becomes difficult for the company to raise more capital as certain shares cannot be sold in the public market.

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Conclusion:

There are many aspects that need to be evaluated when signing up for ESOPs. The Employee Stock Ownership Plan is a good plan as it helps employees access certain shares of the company. It provides a variety of significant tax benefits for companies and their owners. Most companies with ESOP has shown a positive outcome of employee performance. Likewise, the perquisite tax on the exercise of the option and capital gains tax, if sold within one year, maybe a drawback on your investments, particularly if the sum is high.

Author: Hariharan

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