What Is Employee Stock Ownership Plan- Esop - DOC Download

Hi,

I am a new member on this portal. No doubt, it's one of the best portals with such online Q&A facilities. I would request anyone to help me in understanding ESOPs being offered in the software industry. If you have any detailed write-up that can help me understand this from the basics, I kindly request you to forward it to me at my email address: roshanrawat@yahoo.com. Thanks, and I hope to hear from many experienced individuals like you.

Regards,
Roshan

Hi,

In the newspaper portal of Business Standard, if you search, you can find some good articles on ESOPs which can help you understand it better. Have a nice time.

Hi Neha,

Please find attachments explaining ESOP. Anyone having more detailed information regarding this, please share.

Regards,
Roshan

Some more information

Employee Stock Ownership Plan (ESOP):

An ESOP is a defined contribution employee benefit plan that allows employees to become owners of stock in the company they work for. It is an equity based deferred compensation plan. Several features make ESOPs unique as compared to other employee benefit plans. First, only an ESOP is required by law to invest primarily in the securities of the sponsoring employer. Second, an ESOP is unique among qualified employee benefit plans in its ability to borrow money. As a result, "leveraged ESOPs" may be used as a technique of corporate finance.

How does ESOP work?

• 1. The ESOP operates through a trust, setup by the company, that accepts tax deductible contributions from the company to purchase company stock.
  
  2. The contributions made by the company are distributed to individual employee accounts within the trust.
  
  3. The amount of stock each individual receives may vary according to pre-established formulas based on salary, service, or position.
  
  4. The employees may ‘cash out’ after vesting in the program or when they leave the company. The amount they may cash out may depend on the vesting requirements.
  
  5. When an ESOP employee who has at least ten years of participation in the ESOP reaches age 55, he or she must be given the option of diversifying his/her ESOP account up to 25% of the value. This option continues until age sixty, at which time the employee has a one-time option to diversify up to 50% of his/her account. This requirement is applicable to ESOP shares allocated to employee's accounts after December 31, 1986.
  
  6. Employees receive the vested portion of their accounts at either termination, disability, death, or retirement. These distributions may be made in a lump sum or in installments over a period of years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP accounts right away.

Advantages

* Capital Appreciation. Companies sell some or all of their equity to employees and by doing so convert corporate and personal taxes into tax-free capital appreciation. This allows the owner to sell 100% of his or her company, get money out tax-free and still maintain control of the company.

* Incentive Based Retirement. Provides a cost-effective plan to motivate employees. After all, who works harder, owners or employees?

* Tax Advantages. Enables tax advantaged purchasing of stock of a retiring company owner. With this purpose, a company owner may sell their shares to the ESOP and incur no taxable gain on the sale. A company owner can sell all or some of the company to the employees cost free. Owners who sell 30% or more of their company to an ESOP are allowed to "roll-over" the proceeds into other securities and defer taxation on the gain.

* Company reduces it's tax liability. A company can reduce its corporate income taxes and increase its cash flow and net worth by simply issuing treasury stock or newly issued stock to its ESOP.



Disadvantages

* Dilution. If the ESOP is used to finance the company’s growth, the cash flow benefits must be weighed against the rate of dilution.

* Fiduciary Liability. The plan committee members who administer the plan are deemed to be fiduciaries, and can be held liable if they knowingly participate in improper transactions.

* Liquidity. If the value of the stock appreciates substantially, the ESOP and/or the company may not have sufficient funds to repurchase stock, upon employees’ retirement.

* Stock Performance. If the value of the company does not increase, the employees may feel that the ESOP is less attractive than a profit sharing plan. In an extreme case, if the company fails, the employees will lose their benefits to the extent that the ESOP is not diversified in other investments

What is the best way to implement ESOP?

1. Determine how you want to use the ESOP. Will it be used as an employee benefit plan? Or, as an incentive program?

2. Conduct a feasability study to determine the value of the company’s stock and impact of the contributions that must be made to the trust.

3. An ESOP requires different accounting procedures and a different method of allocating stocks and other investments among the employees than other types of plans. For this reason the plan should be designed by an ESOP specialist in order to avoid IRS difficulties.

What are the alternatives to ESOP?

1. Employee stock options.

2. Profit Sharing. An ESOP differs from a profit sharing plan in that an ESOP is required to invest primarily in employer securities, while a profit sharing plan is usually prohibited from investing primarily in employer securities.

Where are ESOP websites?

1. http://www.the-esop-emplowner.org/

2. http://www.cpateam.com/tax-esop.htm

3. http://www.esop.org/info/esop-howto.html

4. http://www.nceo.org/

Hi All,

ESOPs are out, and RSUs are in

Motivation Through Restricted Stock:

Issuing restricted stock is a better motivating tool than granting stock options for two reasons. First, many employees don't understand stock options. They don't know that they have to take action to realize any gain. It is far easier for them to understand a vesting period on restricted stock.

Second, restricted stock can't become worthless like stock options. Even if the stock price falls, restricted stock retains some intrinsic value.

Employee Ownership through Restricted Stock

One of the advantages restricted stock has from a management perspective is it is better at motivating employees to think and act like owners. When a restricted stock award vests, the employee who received the restricted stock becomes an owner of the company. He or she has to take no further action to make it happen. The employee is now part owner and can vote at the annual meeting.

Actual ownership of part of the company is a powerful motivating tool in trying to get employees to own the company's objectives. This makes them more focused on meeting goals.

Stock options, on the other hand, do little to instill a sense of ownership. They are viewed by most as a high-risk gamble that has a potentially great reward. An individual may very well invest a couple of years helping a company grow and prosper when compensated for that time by stock options. However, their loyalty is to raising the stock price so they can cash out and make a bundle. They have no loyalty to the company and its goals. Often, they will choose actions that raise the stock price in the short term, thus increasing their potential gain, rather than taking a longer-term view that will help the company.

FAQs on RSU:

Question: What is restricted stock?

Answer: Stock is ownership of a company. When that stock has limitations on it, it is said to be restricted.

Question: What kind of restrictions?

Answer: One of the most common restrictions requires a certain length of time to pass or a certain goal to be achieved before the stock can be sold. This is the vesting period.

Question: What is a vesting period?

Answer: The vesting period is the length of time before the restrictions are lifted. If the restricted stock is awarded based on the employee remaining with the company for two years, those two years are the vesting period. If the stock vests when "gross sales increase beyond $30 Million," the vesting period is however long it takes for that to happen, if it ever does.

Question: What happens if I leave the company before my stock vests?

Answer: You forfeit the stock.

Question: How does a restricted stock award differ from a stock option grant?

Answer: Both have a vesting period.

The difference is at the end of the vesting period. When a stock option vests, you have the option of purchasing or not purchasing the stock at a specific price (the strike price). You do not own any company stock until you exercise the option and purchase the stock. As soon as you purchase it, you can do anything you want with it, including sell it. When a restricted stock award vests, you own the stock and you can do whatever you want with it.

Question: Which is better, stock options or restricted stock?

Answer: That depends on the change in the stock price. Generally, if the stock price is going up, stock options are a little better. You can sell both at the higher market value, but with stock options, you have not had to commit to the purchase until the stock price reached the point at which you wished to sell. However, if the stock price stays the same or goes down, restricted stock is better. Since you actually own the stock, it retains some value until the stock price goes to zero.

Question: Are restricted stock awards the same size as stock option grants?

Answer: Generally, restricted stock awards are smaller than stock option grants by a factor of two or three (one-half or one-third the size). If a stock option grant were 100 shares, a restricted stock award would usually range from 33 to 50 shares. This is because at the end of the vesting period, the 33 to 50 shares would still have some value and the 100 stock options might not.

Question: Are there tax considerations with restricted stock awards?

Answer: Yes. Be sure to consult a qualified accountant or attorney.

Thanks,

Annu