ESOPs as Employee Benefits

INDIRA WADHAWAN
MBA-4544/07
TRAPTI SINGH CHAUHAN
MBA-4033/07
ESOPs is not a generic term and is
used for both
Employee stock option plan
Employee stock ownership plan
(USA)
 Employee Stock Options
• reward top management and "key" employees
and link their interests with those of the
company
• options are the most prominent form of
individual equity compensation
• A stock option gives an employee the right to
buy a certain number of shares in the
company at a fixed price "grant" for a
certain number of years
• Allows employees to "cash in" by exercising
(purchasing) the stock at the lower grant
price and then selling the stock at the
current market price
• two principal kinds of stock option with
unique rules and tax consequences:
 incentive stock options (ISOs)
 non-qualified stock options
 Nonqualified Stock Options
• number of types of options to purchase company
stock that, does not satisfy the legal requirements
to qualify as an ISO or a purchase plan option.
• taxable to the employee at grant only if it has a
readily ascertainable fair market value at that
time, which nonqualified stock options almost never
do. If it does not have such a value at grant, it is
generally taxed at the time of exercise
• the employer is able to give them a tangible reward
for their efforts without using any liquid cash
resources. As a result of the option, employees
receive an opportunity to share in the future
growth of the company.
• The regulations create an irrebuttable
presumption that an untraded option does not
have a readily ascertainable fair market value
unless four conditions are met, including the
following:
 The option is transferable by the optionee.
 The option is exercisable immediately in full by
the optionee.
 Neither the option nor the underlying property
is subject to any restrictions that have a
significant effect on the option's value.
 The purchase fair market value of the option
privilege is readily ascertainable. Therefore,
almost all options for stock not actively traded
will be deemed not to have a readily
ascertainable fair market value.
 PHANTOM EQUITY
• best suited for executive plans
• refers to plans such as phantom stock or
stock appreciation rights (SARs) that
provide employees with a payout, usually in
cash, based on the increase in the
company's stock value.
• Employees may receive stock instead of
cash, and phantom stock can include
phantom dividends, etc., but the basic idea
is a bonus based on the company's stock
performance.
Employee Stock Ownership Plans
• Equity based contribution benefit plan
• Like profit sharing, an ESOP includes at least
all full-time employees meeting certain age and
service requirements.
• Employees do not actually buy shares in an
ESOP. Instead, the company contributes its own
shares to the plan, contributes cash to buy its
own stock (often from an existing owner), or,
most commonly, has the plan borrow money to
buy stock, with the company repaying the loan
 How does ESOP work?
• The ESOP operates through a trust, setup by
the company, that accepts tax deductible
contributions from the company to purchase
company stock.
• The contributions made by the company are
distributed to individual employee accounts
within the trust.
• The amount of stock each individual receives
may vary according to pre-established formulas
based on salary, service, or position.
• The employees may ‘cash out’ after vesting in
the program or when they leave the company
depending on the vesting requirements.
• 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.
• 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.
 BENEFITS OF ESOPs
• Benefits to sellers:
 Opportunity for superior price
 Potential continued relationships with the
company
 Reduced financial risk
 Potential for tax advantaged sale proceeds
 Opportunity for wealth creation
• Benefits to employees:
 Improved relationships between employees
and management
 Favorable tax treatment compared to other
benefit plans
 Potential for wealth creation
 Sense of company ownership for ESOP
participants
 Put option by law
 Increased morale and loyalty
 ESOP loan is non-recourse to employees
 Retirement plan correlated with employee
performance
THANK YOU