what is an employee share ownership plan (ESOP)

An employee share ownership plan (also known as an ‘employee stock ownership plan’) is a benefit program that allows workers to become shareholders in the corporation they work for. The business offers the shares to staff at no upfront cost as part of their overall compensation package. Both public and private companies can support an ESOP.

This approach not only aims to reward employees but align their interests with your company’s objectives. By having a stake in your success, teams may feel more motivated and committed to their work.

How does an ESOP work?

Your business can start an ESOP by opening a trust fund into which you contribute new shares or cash to buy shares. Alternatively, you can borrow money to buy new or existing shares and make repayments over time.

Employees then receive a portion of the company stock in their account based on factors such as:

• Seniority
• Tenure
• Role
• Salary
• Performance

ESOPs typically come with a vesting period, meaning workers need to remain with your organization for a period before they gain the rights to their accounts. This strategy ensures that your team is invested in the company’s long-term success as the value of their shares is tied to their tenure and the company’s ongoing performance. Once vested, employees can sell their shares back to your business at fair market value when they leave or retire.

You don’t have to limit ESOPs to full-time employees. Plenty of companies now offer profit-sharing to contractors as well.

See also: Owning Equity as an Independent Contractor with Deel

What role does an ESOP play in a company’s compensation strategy?

An ESOP serves as a valuable tool for attracting, retaining, and motivating employees. It can complement your traditional compensation packages by offering staff a long-term benefit that can act as part of their retirement plan.

If your cash flow is tight, ESOPs provide a way to offer competitive compensation packages without straining your budget. You can reward employees for their hard work without having the cash upfront.

What are the benefits of an ESOP?

Implementing an ESOP can have significant advantages for both employees and the company, including the following:

Increased engagement and productivity

ESOPs can be a lucrative employee benefit plan. As the company grows and becomes more successful, so do the ESOP shares, potentially leading to more substantial retirement savings. This setup provides workers with more financial security, thereby reducing stress and enhancing overall well-being.

With an ownership interest in your company, employees are also more likely to be invested in business outcomes. They’ll be more engaged in decision-making and committed to meeting your key objectives when they directly benefit.

Improved company performance

In a competitive job market, an ESOP is a cost-effective way for a business to differentiate itself. You can offer attractive compensation and get the talent you need without the immediate cash required for higher salaries.

Since you only make distributions when the company is profitable, there’s no risk of depleting your resources. You can ensure your business maintains financial stability and security.

Enhanced succession planning

When business owners are ready to move on or retire, an ESOP offers a streamlined way for them to pass their shares to employees. The process can be gradual, allowing for a smooth transition with less disruption than traditional sales or mergers. As the company will remain in familiar hands, this also ensures business continuity and preserves its culture.

Tax benefits

Any contributions to the ESOP are usually tax deductible leading to immediate tax savings for your company. These savings extend to any loan repayments you make toward the plan. If you’re an S corporation, the ESOP’s share of the business income isn’t subject to income tax either.

Employees also receive tax advantages from ESOPs. They don’t pay tax on allocations and can make deferred payments on distributions if they roll the money into an IRA or other type of retirement account.

How can a company set up an ESOP?

Setting up an ESOP usually involves the following steps:

• Determine the company's objectives for the ESOP
• Design the plan structure, including eligibility and vesting schedules
• Obtain a valuation of the company to determine share prices
• Create a legal plan document based on local guidelines
• Set up an ESOP trust to hold the shares
• Allocate shares to eligible employee accounts
• Communicate the plan details and benefits to employees
• Manage and maintain the ESOP, including annual valuations and record-keeping

How can you measure the success of an ESOP?

ESOPs can have a positive impact on both your company’s financial health and your team’s well-being. You can track the following metrics to measure the success of your plan:

• Number of ESOP participants
• Employee feedback ratings
• Productivity and engagement levels
• Recruitment and retention rates
• Company shares value
• Profit margins
• Tax savings

What are the legal or compliance risks associated with ESOPs?

ESOP companies are subject to a variety of legal and regulatory requirements. Companies must ensure they comply with Employee Retirement Income Security Act (ERISA) standards in the US or foreign equivalents. Mismanagement of an ESOP can lead to legal disputes or large penalties.

Additionally, business owners have substantial fiduciary responsibilities toward the plan’s participants. Administers must act in the best interest of employee owners because any perceived conflicts of interest could result in legal action.

Services like Deel can help you with equity management including structuring plans compliantly, reporting taxes correctly, and storing documents. We also notify you of any changing regulations that could impact your ESOP management.

How can an ESOP fit into the trend for remote work?

As companies increasingly adopt remote work models, ESOPs can maintain and enhance employee engagement. Being involved in a plan can reinforce your team’s sense of belonging and investment in business success, regardless of their physical location.

Providing teams with remote access to their ESOP details via a centralized platform like Deel ensures transparency and consistency across borders. We sync with your equity management system so you can easily transfer data and create reports for employees.

See also: How to Grant Stock Options to Foreign Employees

How can you adapt an ESOP for a global workforce?

Companies must tailor their ESOPs to comply with laws and tax regulations in every country where they have employees. You may have to create multiple versions of the plan or adjust the terms to fit local requirements.

Working with local partners or advisors can help you navigate the complex process of international ESOP management. Global providers like Deel allow you to implement plans across different locations while consolidating your operations. We currently have equity management in over 110 countries.

If you don’t have a presence in a county, Deel also allows you to implement plans through our employer of record (EOR) service. We hire employees on your behalf and manage all the compliance, HR, and payroll operations.

Deel’s unique legal framework helps you avoid the risk of permanent establishment in countries that consider ESOP grounds for co-employment with the EOR. You won’t inadvertently trigger tax liabilities and face double taxation.

See also: How Deel Simplifies Granting Equity to EOR Employees