What is a ESOP and How to do ESOP Valuation?
ESOPS are Employee Stock Ownership Plans where a trust holds the stock of the employers for the benefit of the employees. Primarily, the trust acquires the stocks from the employer or from the shareholders of the employing company that has floated the stock in the market. Basically, it is a retirement plan that is loaded with tax advantages. When you retire, you would benefit like all the other employees from the stocks that the trust has held.
Pros and cons of ESOPS:
Usually, the purchase of the stocks by the ESOPS is financed by banks or financial institutions and the employer stands guarantee for the loan amount. Over the years, the employer or the company will contribute amounts in cash to the ESOP that would be free from tax. Usually, the contributions are done on a yearly basis and the ESOP will utilize the money to repay the loan. There would be predetermined share distribution plans to the employees laid out. According to the pre set requirements, the employees will benefit from the distribution of the stocks of their employer or the company they work for.
Employees stand to gain in this type of a scenario as they are not slapped with any tax liability for getting their share of stocks. It is only when they decide to sell the shares of the employer that they would become liable to pay tax. There is a flip side to it. It has happened in some instances when the market goes on a negative spin. During the recent tumble down of the stock market in the US, many employees lost their savings as they held on to the stocks to avoid any tax liability.
But when the markets crashed, the shares of the company they worked for and distributed to them, fell in value. These are rare occurrences, but could happen whenever the economy goes on the skids.
Both the employee and employer benefits
But the primary advantage lies with the employee as he or she does not have to pay tax when the employer makes the yearly contribution in cash or when the stock is distributed under the ESOP plan. While the employee benefits at the end of the day and even when the cash contributions are made, the employer benefits during the time of the contribution by being eligible for deduction. Current deductions or the contribution of stocks is what the employer can benefit from. But maintaining the ESOP can sometimes not be cost effective always and its creation involves lots of data and information that has to be prepared.
The employer would also have to routinely conform to retirement plan regulations that are changed from time to time or adapt to changing rules. Problems could also come about as the employer would be locked in a sharing arrangement with the employees. As an employee, you could also gain immensely if your company stock does well and you sell at a high rate.
The difference between the base price of the stock and the amount you would receive after the sale would be taxed as capital gains, but you could still make a huge gain. But the employer would view it as selling your company to outsiders. But anyway, the purpose of ESOP was meant to provide you with this alternative. ESOPs are commonplace in the US and have been gaining popularity since 1974.
According to recent estimates, there are nearly eight million employees covered under ESOP and nearly 11,000 companies coast to coast that are using the option of employee ownership. Many companies use it primarily to motivate employees by providing them with a profit sharing incentive.
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