Understanding the in’s and out’s of Employee Share Ownership Plans is the first step to assessing whether or not they are a fit for your company. We’ve assisted with the implementation of well over 175 ESOPs over the past twenty years and consulted and partnered with many others companies. Through those experiences, we’ve been able to compile a list of common questions.
If you don’t find what you’re looking for here, or have any remaining questions, please reach out to us directly—we’d love to help:
1. What are the ways to transfer ownership to employees?
There are three options, or a combination of these.
- Equity stock – these are actual shares of the company. The total value of the equity stocks equals the value of the company. The value of the shares increase and decrease depending on a number of factors (see # 3 below). Shares can be common or preferred, voting or non-voting, and typically have a right to dividends, should those be declared by the Board.
- Equity units – these units mirror a share, although they are not a share in legal terms. They are valued the same as a share, although payments to unitholders are called distributions and are considered the same as employment income in the hands of the unitholder.
- Stock options – a stock option is a right conferred by the company upon an employee to purchase shares of the company at a fixed price and up to a certain future date. Stock options are an accepted industry standard of compensation for employees because they reflect the ability of the employee to influence future growth and value of the company.Generally, the employee will only exercise the option to buy a share when the share value is above the option exercise price. For example, the option would be exercised if, within the vesting period, the company value had grown such that the share value was significantly greater than the option price. Another example is if the company went public (an Initial Public Offering), as the anticipated rise in the share value would result in a profit to the shareholder.
2. What are the typical methods of allocating shares to employees?
Generally accepted methods of allocating stock equity, units or stock options include salary or commission level, position (e.g. executive, management, staff), years of service or a combination of these. There may also be other considerations which management may wish to include such as individual contribution and effort or results achieved.
3. How do you determine the value of the company and the shares?
A valuation of the company is necessary in order to determine the price at which the employees can buy or sell shares. Unlike a public company where the shares are traded every day on a stock exchange at whatever the value the market determines, private companies have no market in which to trade.
Consequently, a value known as the Fair Market Value (FMV) must be determined. This can be done annually using an independent chartered business valuator for each fiscal year end. The value of a company lies in its potential to generate a return in the form of dividends and/or growth in share value. A number of factors are considered such as historic profit growth, future growth potential, market potential, management expertise, economic conditions, etc.
4. Do ESOPs offer better compensation than other incentive plans?
Many people consider shares in a private company to be a valuable financial asset compared to shorter-term bonuses and profit sharing. Early stage companies may be undergoing rapid expansion with the longer-term goal of an Initial Public Offering (IPO). Consequently, employees who own stock in a private company that goes public can end up receiving a significant capital appreciation in their share value. A good illustration of this is Microsoft.
5. How can employees cash out their shares?
The ESOP is designed to be a long-term plan, which rewards employees for remaining with the company. In general, most ESOPs allow for employees to sell their shares if the company goes public, is sold or merged or if the employee leaves the company. However, there would likely be different terms depending upon which scenario occurs.
6. How long does it typically take for a company to implement an ESOP?
ESOP design and implementation can take anywhere from three to six months, and most often it takes four. This time is important in order to ensure all parties—employees and owners—are informed, build understanding, and present employee education sessions. Our priority is that your plan is successful, generates meaningful buy-in, and all stakeholders understand why the plan has been implemented and what the benefits are to the company and individual.
7. Will an ESOP work in any industry?
We’ve implemented ESOPs in almost every industry and find that they tend to thrive across the board. Any business where employee engagement is a priority could benefit from implementing an ESOP. That said, in fairly specific instances, such as within hierarchical unionized environments, we’ve found ESOPs do not work as well.
More questions: Complete our Feasibility Survey to assess your company’s fit or contact us directly to learn more!