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.