A company that wants to supplement its employees’ salary with equity compensation can do so with an employee share ownership plan (ESOP). Besides offering employees a potentially valuable ownership stake in the company, ESOPs can be an important tool for companies, particularly in succession planning.
What is an employee share ownership plan?
An ESOP gives qualifying employees the opportunity to acquire a stake in the company’s success, through a variety of methods. An ESOP can use any or all of the following approaches to employee ownership.
Equity shares. An ESOP can award shares directly, with no monetary investment from the employee. Shares typically “vest,” or become the property of the employee, after a period of time. This provides an incentive for the employee to stay with the company for several years.
Stock options. Instead of directly awarding employees with shares, the company may give employees the right to buy stock at a specified price on a specified future date. If the value of the company rises by the time that date rolls around, employees will be able to buy shares at a discount. (If the company is not a Canadian-controlled private corporation (CCPC), you will owe tax on half of that discount.)
Phantom equity. If employers want to invite employees to share in the company’s success without conferring ownership rights, they can issue “phantom” equity. The employee receives mock shares that track the price of real stock and pay out at some future date, but they gain no voting rights, and their phantom equity won’t dilute extant company stock.
ESOPs can also differ by participation level. A company can open its ESOP to all eligible employees (a broad-based plan) or limit participation to individuals in critical positions or with critical skills (a key-person plan). A broad-based plan may boost morale throughout the organization and avoid resentment among excluded employees. A key-person plan, on the other hand, targets investment in those employees who are most responsible for building value.
Benefits of an ESOP
Some people advocate ESOPs because they have an ideological commitment to employee ownership. Outside of this, ESOPs have several specific advantages:
- Recruitment and retention. ESOPs can sweeten a job offer and attract employees, particularly for companies that expect to grow over the long term. As a benefit that accrues over time, an ESOP can also act as an incentive for workers to stay with a company until they can get the most out of their ESOP. The employer’s hope is that an ownership stake will motivate employees to work hard to help grow the business, as they stand to benefit from its long-term success.
- Succession planning. An ESOP is a popular succession planning tool. Outgoing owners without a ready buyer or who want to sell their portion of ownership to their employees can sell their stake to the ESOP, either gradually or all at once.
Establishing an ESOP is a multistep process that includes a feasibility study, a valuation of the business, and the help of an attorney in drafting the plan according to the laws in your province. Depending on the needs of the business, an ESOP can be a powerful tool with benefits for both employees and employers.
SOURCES:
https://www.esopcanada.ca/content.aspx?page_id=22&club_id=925161&module_id=409825
https://www.investopedia.com/terms/p/phantomstock.asp
https://www.mondaq.com/advicecentre/content/2688/Employee-Stock-Options
https://www.ownr.co/blog/employee-stock-option-plans-for-canadian-startups/
