What is an ESOP?

What is an ESOP?

ESOP is an acronym for an employee share ownership plan or employee stock ownership plan. This is where employers give company shares to employees as part of their remuneration plan as an added bonus or allows them to buy shares at a predetermined price up to a certain amount.

To ensure the shares remain tax exempt, the employee must keep their shares for three years or until they leave the company.

How does a company create an ESOP?

Firstly, a company needs an ESOP document and a trust account. This is where a commercial lawyer with employer-facing experience can assist.

Then the employer will make annual contributions to the trust account of either tax deductible contributions or cash to buy company shares, or both.

Even though the trust will own the shares, contributions of shares are made to the individual accounts of the employees (within the trust account).

Benefits of an ESOP

An ESOP can provide numerous benefits both to the company and the employee such as:

  • Can align employees’ interests with those of the shareholders;
  • A company may be able to retain key employees;
  • Can provide a further incentive to boost a remuneration package;
  • It can increase staff loyalty and reduce staff turnover;
  • It can give employees an increased sense of ownership and association with the company;
  • It can enable the employees to have some influence regarding key business decisions; and
  • Can provide financial rewards for employees.

Disadvantages of an ESOP

  • The money involved with setting up a plan and managing it.
  • If the company performs poorly or its share price go down, an employee may feel they have no control over the outcome and it can affect morale.
  • An employee can feel that they have all of their eggs in the one basket – so if the company does not do well or goes into administration or liquidation – the employee loses out.

What happens if you leave the company?

If an employee leaves their employment, the unvested shares lapse. The vested shares do not lapse, but the company can choose to have the shares transferred for a fair market value.

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