It is not uncommon for SME employers to boost employee engagements with some forms of ownership. Employees can receive stock options, bonus, or even stock directly. However, one of the most common ownership is known as Employee Stock Ownership Plans, or ESOP.

Employee Stock Ownership Plans (ESOPs) – Whom are they for?

An ESOP benefits both the employer and the employee in many ways. Besides the obvious employee motivation and monetary benefits, there are strong tax advantages for both employees and employers. For employees, income earned in the ESOP accounts are not taxed until the benefits are received by the employees. And for the employers, contributions to the plan are tax-deductible, with limits.

How do business owners use ESOPs?

There are a number of reasons for business owners to implement ESOPs. First and foremost, the company can provide employees an additional layer of benefit in conjunction with other saving plans. Company can also use a leveraged ESOP. A leveraged ESOP would borrow cash and essentially raise capital for the company. The company will then make contributions to the ESOP. Since the contribution made is tax-deductible, the company’s cost of borrowing is lower.

Considerations before you decide to include an ESOP

Make sure you have a strong financial management system and a valuation

There are a number of things that a business owner should consider before including an ESOP. The company owner must ensure the company’s financial management infrastructure includes all the essential building blocks such as monthly budget, forecast, and cash flow planning. A strong financial management practice not only provides analytics for the management team but also insights for management’s ESOP transaction planning and capital allocation decisions. In addition, the company requires a fair market valuation for the company when the ESOP buys and transfers shares of the company. The company must update and provide a fairness opinion for the ESOP annually and ensure the valuation is acceptable by both tax and pension plan authorities.

Shareholder Agreement Reviews

Want to sell or recapitalize your company? Maybe it’s time to review your company shareholder agreement. Owners might be surprised some of the things they are allowed or not allowed to do. A shareholder agreement can get complicated quickly once you have more shareholders because the shareholder agreement is typically used to define what happens in all subsequent transaction in a given company’s shares. There are many items in the agreement and sometimes these items might even have major conflicts with each other.

Types of Shareholder Agreement

There are typically two types of shareholder agreement, unanimous and ordinary. An unanimous shareholder agreement gives responsibility to the shareholders and usually has restrictions on what the director can or cannot do. On the other hand, an ordinary shareholder agreement gives the description of relationships of the shareholders’ powers and roles as owners of the company, rather than restricting directors’ ability to manage the company.

When should you review your Shareholder Agreement

Beside an Exit, business owners should review the shareholder agreement on any triggering event such as the death of a shareholder, insolvency or bankruptcy of a shareholder, or change of the method use in calculating the company’s tangible or intangible assets.

The shareholder agreement should also have clear instructions for share sale including simple buy-sell provisions and right of first refusal or first offer where shareholders have the right to buy when the other shareholder decide to liquidate. To ensure fairness, there are provisions for majority and minority parties of a company as well. But the often missed item is the value and payment terms and how they might change given the triggering events. Shareholder agreement can also determine alternative ways to derive company value.

Speak to your business attorney to understand what you need to know about your shareholder agreement and the definition of value. When in doubt, make sure you speak to a chartered financial professional for your need.