What are ESOPs?
Read this guide to learn everything you need to know about Employee Stock Ownership Plans
An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company; this interest takes the form of shares of stock.
Each of us sometimes feels a lack of motivation or monotony in our actions. Most professions are associated with the repetition of activities with a certain rhythm and, unfortunately, the lack of new stimuli. Being aware of this fact, executives try to diversify the working time of their employees as much as possible, giving their activities and tasks a higher meaning and purpose in order to keep them motivated.
The feeling of climbing the ladder of a career is certainly a way of doing this.Employees strive for the promotion and try to make their actions met with appreciation also financially. Bonuses and various types of benefits are patterns repeated in all companies. Superiors and managers reward employees with gifts pay rises, promotions, and the prestige of senior positions. They know how important it is to engage employees in work because it is the most important factor contributing to the success of any company, regardless of the industry.
Better Business Act, inclusion, and diversity movements engaging companies in ecological, charity and equality activities are all measures aimed at giving work and everyday activities – sometimes repetitive and tedious – new meaning and ambition. A similar action is aimed at the phenomenon known as ESOP – Employee Stock Ownership Plan, in which ownership interest provides tax-deductible cash contributions.
An employee stock ownership plan means significant tax benefits, company stock, and capital gains.
This program assumes remuneration of the employee in the form of resale of the business shares in which he works. It is usually a form of praise and recognition. It is carried out under the so-called “Vesting” or a bilateral agreement in which the employee undertakes to remain part of the business for, for example, several consecutive years, which will allow him to buy a part of the business shares, or simply offer them as a bonus.
In countries with developed economies, the solution in the form of transferring business shares to employees is a common procedure. It is used by companies listed on stock exchanges, valued and extensive corporations, as well as smaller startups. The program is often used by low-income, fresh start-ups on the market that do not yet have the financial resources to reward employees with cash.
It is also undoubtedly a tool for finding talent and a way to keep investors, founders and originators in start-ups. Employee Stock Ownership brings two results; motivation and loyalty.
The employee opens a document confirming that his work and its results are inextricably linked with the performance and possible success or failure of the company. Feeling this kind of responsibility, the employee so far – devoted to the boss and management, made sure that the company was in constant development. Now it is not only them who will be financially responsible, but also to himself. Being part of the success or failure.
Employee benefit plan participants.
There are many types of Employee Stock Ownership Plan implementation. Employees have the option to buy stocks directly, receive them in the form of a bonus and incentive to continue working hard, or receive them successively as part of profit sharing. Some employees become owners thanks to employee cooperatives, where everyone has the same opportunities.
The most common, however, in the USA is an ESCOP-type plan as employee shareholding. It is a relatively new remuneration system, as it did not become widespread until the 1970s. According to today’s analysis, the number of ownership plans reaches 6,460 and covers almost 15 million people.
A press release from the European Federation of Employee Stockholders (published on 31 March 2021) states: “In 2020, the development of employee stock ownership continued in large European companies. More and more of them organize employee share ownership programs. In 2020, 94% of all large European companies had employee share ownership programs, of which 88% offered various employee share ownership programs, while 53% had employee share ownership programs. “Broad base” targeted at all employees, and 60% – stock options programs. Finally, 29% of all large European companies have introduced new employee share ownership programs, and this percentage shows an increasing trend every year ”.
Fair market value.
ESOP has many applications in the business world, and contrary to public opinion, it is not used to save companies that have found themselves on the verge of bankruptcy. Of the total number of ownership plans undertaken for company stocks, those that do not earn or struggle with debts or financial problems are only a small percentage.
Typically, ESOP-type ownership and share plans are used to provide market and liquidity in the shares of owners who choose to resign, motivate employees, reward them for acting on behalf of the company and try to tie them to the brand even more, making the work more personal, with regardless of the state of possession.
In addition, a significant reason for taking this type of action is to persuade people to borrow money to buy dollar-denominated assets before they are taxed. ESOP is a show of good will for the benefit of an employee who shows commitment and determination in acting for the benefit of the company, and not an employee purchase.
Employee stock ownership plans.
Each country has an ESOP policy that is typically different. Due to the need to adapt the solution to tax laws in a given country, there are usually many differences. However, the purpose and rationale of the ESOP program are similar everywhere.
ESCOP is a type of employee benefit with many aspects in common with a profit sharing plan. A company that sets up a trust fund sets up a trust in this program. In its composition, the company puts new shares, or cash outlays, to buy more shares and thus maintain the liquidity of transactions related to the company’s shares.
In the United States, ESOPs may borrow a financial contribution to buy new or existing shares. The company contributes a cash contribution to the plan, enabling itself to pay off the value borrowed. Regardless of how the company decides to purchase the stock, the company’s contribution is taxed in a certain way. In 2017, the law regulated this issue with a separate tax act. The net interest deduction is limited to 30%, the so-called EBITDA, i.e. 30% of the profit before interest, taxation or financial depreciation, is valid only for 4 years, after which the limit drops to 30% of the value of the so-called EBIT. In a modernized, leveraged ESOP, a firm borrows an amount proportionally greater to its pre-tax profit, i.e. EBITDA. It is then possible that the costs associated with the implementation of the program will be lower than the profit, and this will lead to an increase in taxation. On the other hand, companies subject to 100% of the ESOP policy do not pay taxes. Usually, all employees over the age of 21 are subject to this. Their shares are assigned to employee accounts where the identity is verified. New employees need some time to gain enough trust from the employer to participate in this kind of benefit like ESOP scheme. Most professional corporations create direct stock of zones where any worker cooperatives and gains accumulated potentially favorable rates.
Based on the EFES report, a continuing upward trend can be seen in the number of employees who decided to participate in employee stock ownership programs. 7.1 million people participate in the shareholding structure of large companies in Europe. Taking into account employee-shareholders in the SME sector, the total number of such employees is 8.1 million. In May 2020, incl. Due to the pandemic crisis, the worldwide value of shares owned by employees fell by 40 billion euros compared to the previous year and amounted to 310 billion euros.
However, the beginning of 2021 led to a significant improvement in these statistics and calculations. Currently, employees in the form of shares in companies still hold EUR 420 billion (a record).
As defined above, the Employee Stock Ownership / Option Plan is a program under which an employee, by acquiring shares in the company he works for, may become its co-owner.
Employee ownership provides profit sharing plans but also engagement and trust. Certain limits and cash flow are results of crucial decisions of closely held companies where the departing owner cares of well corporate performance.
The program enables both employees and associates (on a B2B basis), business partners, advisors or the management of the company – the Management Stock Option Plan. The employee then receives an additional source of income. Thus, it affects the development of the company, and the employer recruits the best specialists. Those, encouraged by the competitive bonus, are subject to a significant increase in motivation. As a result, employee rotation, in the form of the willingness to quit the job, is significantly reduced, the company is based on loyal members who feel responsible for the company’s success.
The program also benefits the country in which the company is registered and operates. The national budget is growing, and so is the purchasing power. This leads to leveling the differences in the living standards of the community and wealth, thanks to which the effects of a possible economic crisis are much milder.
Many countries around the world have introduced changes and mechanisms to better organize the enterprise on the level of legal systems, so that ownership programs, including the ESOPs operated more efficiently.
Ideas and programs such as ESOP or MSOP were popular at the beginning of the 20th century, e.g. in the USA and in some European countries (including France, Germany, Poland). The dissemination of the idea began to take shape in the second half of the nineteenth century in the United States. The beginning of the program is rooted in the act on agricultural holdings. They wanted to maintain the tendency to concentrate ownership in the agricultural sector.
Every year, the European Federation of Employee Share Ownership-EFES prepares research and analyzes by clicking on their results. The reports present the results of the employee shareholding analysis in the largest European companies (in 2020, 2,723 enterprises in 32 countries were taken into account).
The number of shareholder-employees has been steadily increasing since 2016. According to the Annual Economic Survey of Employee Share Ownership in European Countries 2020, France, Great Britain and Germany can be distinguished among European countries as countries where this solution is most popular.
Operating on employee stocks at favorable prices is one of the ways to obtain a larger budget for the development of the company.
With this capital, we can effortlessly continue to improve our business. It is a good alternative to a traditional loan, which always involves risk and many activities to meet the bank’s conditions, but most of all time could be spent on working on the development of the company. As a participant of employee stock ownership programs, the employee generates savings and increases his passive income.
An employee using a shareholder scheme is future and retirement secured with an additional source of income and financial insurance. An employee who has been given the opportunity to purchase shares or who have been awarded them feels distinguished, more connected with the company financially and emotionally, as it is a form of reward for the contribution of work. He notices the sense and purposefulness of the actions taken. The added value is also the training of subordinates in the field of economic knowledge during training courses accompanying the implementation of employee shareholding.
As mentioned, it is a relationship that could be described as synergy, where 1 + 1 is 3. The third party benefiting from the program and its beneficiaries is also the state itself. In both the long and short term perspective, steady income in the form of dividends leads to an increase in the personal budget, and this, in turn, constitutes the GDP of a country. Participation in the programs is associated with a reduction in the poverty rate among the retirement group and families benefiting from social assistance programs.
The declining rate of democratization across Europe (with the exception of the United Kingdom) over the past decade has had a negative impact on the delivery of employee programs. EFES argues that the increasing popularity of this type of program is highly endangered, as is the development of the idea itself. Relocation of large companies, rotations in the location of companies’ headquarters and their registration, as well as differences in legal and tax regulations contribute to the chaos of the rules governing the functioning of ESOP and other similar projects. The deterioration of global economies due to the COVID-19 pandemic also plays a large and negative role in the development of employee stock ownership.