What Is an Employee Stock Ownership Plan (ESOP)?

A benefit plan known as an employee stock ownership plan (ESOP) provides employees with shares of stock that represent ownership in the business. Nowadays, ESOPs are considered because startups initially may not be able to afford to pay employees hefty salaries. 

A perfect example of an employee stock ownership plan, which has been trending worldwide, is of a recent hire from Google who received a package worth Rs 1.2 crores a year, half of which was in the form of an employee stock ownership plan. 

Employees in this situation must wait a specific amount of time, known as the vesting period, before exercising their option to buy the predetermined number of shares. Employees may exercise their options to acquire shares at the allotted price, which is lower than the market price. They also gain the right to sell the shares purchased through ESOPs for a profit.

How does ESOP Work?

Employers first determine the number of shares they will offer under ESOPs, the beneficiary employees, and their price. Then they grant these ESOPs to employees, giving them a grant date. These ESOPs then remain in a trust fund for a period called the vesting period. For the employees to avail of stock ownership, they must remain in the organisation for the vesting period.

After the vesting period, employees can buy the company shares at allotted prices that are lower than the market price. Employees can also profit from their holdings by selling the shares bought through ESOPs. 

Benefits of Employee Stock Ownership Plan (ESOP) for Employees

Mentioned below are some of the benefits that employees get through ESOP. 

• Ownership of Company Stocks 

Since ESOPs allow employees to own a portion of the company’s share capital, they feel a sense of ownership in the company they work with. 

• Dividend Income 

Dividends are paid to shareholders as a portion of the company’s profits, divided among them. So, in addition to receiving a direct benefit from their efforts contributing to the company’s performance, employees can also earn additional dividend income.

• Purchase Shares at a Discounted Price

Employees typically pay a small fee to purchase the shares allocated to them while exercising their ESOP rights. As a result, they could invest in the business at a preferential rate.

• Sense of ownership

An ESOP gives employees a sense of belongingness to the organization they work for. With an increase in their productivity, they can contribute to the company’s growth, consequently leading to an increase in its share value. Thus, employees are able to derive the benefits of their hard work indirectly through ESOPs.

Benefits of Employee Stock Ownership Plan (ESOP) for Companies

Let’s now examine the benefits of ESOPs for companies. 

• Retention of Employees 

It is easier for companies to retain employees because they must wait until the vesting time has passed before exercising their ESOPs. 

• Improves Productivity 

ESOPs can increase employee productivity and the firm’s profitability because employees are more motivated to work hard since they stand to benefit from the profits made by the company. 

• Helps in Attracting Talented Employees 

ESOPs are extra compensation options that aid firms in recruiting and keeping talented employees. In reality, ESOPs aid startups in bringing in top employees during the early stages when higher salary packages are impossible. 

Disadvantages of an ESOP

Though ESOPs are advantageous for both employees and companies, there are certain disadvantages. 

• Limited Diversification 

Members of ESOP invest all of their retirement funds in a single business. As a result, employees risk losing their savings and income if their company shuts down.

• Restrictions for New Employees 

Longstanding employees who have enrolled in the ESOP plan earlier gain benefits from their continued contribution to the plan. However, the situation is different for newer employees, who might save less money than long-term employees. 

• ESOPs are Dilutive 

As more employees join a company, shares are allotted to their accounts. This lowers the overall proportion of shares held by older plan participants. 

• Reduces Voting Power of Higher Shareholders 

Voting power is impacted by ESOP dilution since employees with strong voting power due to their higher share count have lower voting powers once new employees are granted shares. 

What Should Employees Know When Using ESOP in place of Salary? 

When using ESOPS instead of pay, employees should take the following precautions: 

• Correct Documents 

Employees are responsible for ensuring that all the documents are in order. They should also consider the current and future value of the shares. 

• Proper Exit Procedure 

They should ensure a suitable exit strategy is in place, such as a promoter repurchase if the startup listing is prolonged.

The Bottomline 

ESOPs are the most popular employee ownership tool because they benefit businesses and their employees. Since ESOPs align the goals of employees and stakeholders, long-term employees and employers favor them over other structures. ESOPs typically encourage increased work and dedication in exchange for more significant financial benefits, benefiting both employers and employees. As a result, ESOPs help both the employee and the company grow.