Employee Stock Ownership Plan (ESOP)

How Does an ESOP Work?

First, an ESOP is set up as a trust fund. Here, companies may place newly issued shares, borrow money to buy company shares, or fund the trust with cash to purchase company shares. Meanwhile, employees can accumulate a growing number of shares, an amount that can rise over time depending on their employment term. These shares are meant to be sold only at or after the time of retirement or termination, and the employee is remunerated by receiving the cash value of their shares.

What Is an Example of an ESOP?

Consider an employee who has worked at a large tech firm for five years. Under the company’s ESOP, they have the right to receive 20 shares after the first year, and 100 shares total after five years. When the employee retires, they will receive the share value in cash. Stock ownership plans may include stock options, restricted shares, and stock appreciation rights, among others.

Are ESOPs Good for Employees?

Yes, ESOPs can generally be considered a benefit for workers. These programs tend to be adopted by companies that don’t chop and change staff frequently and often result in a bigger payout and greater financial compensation for employees.

The Bottom Line

ESOPs are generally a win-win for employers and employees, encouraging greater effort and commitment in exchange for bigger financial rewards. However, they are not always straightforward and can be frustrating if the participant doesn’t fully understand the terms of their particular plan.

Not all ESOPs are the same. Rules on actions such as vesting and withdrawals can vary, and it’s important to be aware of them to make the most of this benefit and not potentially miss out on a big extra bonus.

KEY POINTS:

• An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock.
• ESOPs encourage employees to give their all as the company’s success translates into financial rewards.
• They also help staff to feel more appreciated and better compensated for the work they do.
• Companies typically tie distributions from the plan to vesting, which gives employees rights to employer-provided assets over time.
• It’s important to read the terms of your ESOP, as each one may vary and have different rules.
• Other versions of employee ownership include direct-purchase programs, stock options, restricted stock, phantom stock, and stock appreciation rights.