ESOPs

An ESOP, or employee stock ownership plan, is a program that provides employees with an ownership stake in the company. In the United States, ESOPs are a specialized retirement plan that uses a trust to hold company stock on behalf of employees. The plan is funded by the employer, through either contributions of stock or cash that the trust uses to buy stock, or by borrowing to purchase shares (a leveraged ESOP).

Shares are allocated to individual employee accounts based on a formula, often compensation or years of service. Vesting schedules determine when employees gain full ownership rights; typical ranges run over three to six years. When employees leave or retire, they receive the value of their vested shares, usually paid by the company or the ESOP trust. The company may also pay dividends on ESOP-held shares, which can be distributed in cash or reinvested.

Tax and financial aspects: Employer contributions are tax-deductible, and employees do not pay tax on allocated shares until the point of distribution or sale. Upon distribution, the amount is taxed as ordinary income; when shares are later sold, any gain may qualify for capital gains treatment. ESOPs can increase liquidity for owners and may be used to buy out the owners or to finance growth.

Benefits and limitations: ESOPs can align employees with company performance, create employee loyalty, and provide a succession plan. They also introduce complexity, regulatory compliance requirements, and potential dilution of ownership. ESOPs are most common in mid-sized privately held companies.

Global context: While ESOPs originated and are most prevalent in the United States, similar ownership plans exist in other countries under different names, with varying tax treatment and regulatory rules. Differences include eligibility, diversification rights, and funding mechanisms.