ESOP Benefits for Employees, Business, and Shareholders (Part 6 of 10)
By Joanne Hue, published: 2023-04-08
Employee Stock Option Plan is equity finance that allows the employees of a business to own shares in the company they are working for. It allows companies to boost the productivity of their employees by providing them with benefits contingent on the appreciation of the company’s value. In this way, ESOPs orient the interest of their workers with that of their shareholders. Most nations have laws allowing tax benefits for stock option plans for the holder and the company. ESOP structures can be extremely efficient in strengthening a company. If you are an employee or a business owner exploring the benefits of ESOP this article will help you understand it.
Option Scheme Benefits for Employees
ESOP offers a large array of benefits for employees. Some of the important ones have been listed below:
1. ESOP provides an opportunity to acquire wealth
Numerous examples of successful ESOP exercises have helped employees acquire millions. ESOP is essentially an equity option for the employees. ESOP helps the participant increase equity exposure in their financial portfolio. Equity options are generally considered an excellent opportunity for investors to create long-term wealth. ESOPs help you increase the equity exposure in your financial portfolio. Other financial incentives like compensation or bonus can be great for the short term. However, stock option plans are helpful to create long-term wealth. short term. If the shares acquired through stock option plans significantly appreciate, it can help create generational wealth for your family.
2. Ownership in the company you work with
Employee Stock Option Plans allow you to own a portion of the company you work for. This means you are no longer working for the company, but are a partner in the business. ESOPs can be an excellent way to garner a sense of belongingness amongst employees. If you are an employee with a stock in the company, the productivity that you bring to the table is directly beneficial to you. In this sense, you are not simply working for a paycheck, but have a deeper interest in the success of the company. Having a stock option plan ensures that an employee does not feel like they are toiling for someone else. The appreciation of the company’s value incentivizes the employee to exercise their rights and earn a profit. An option plan allows the employee to benefit directly from their hard work. When an employee has stocks in the company they work for, they are more likely to be trustworthy and diligent.
3. The Option to Time Investments
An employee may not always exercise their rights immediately. Since companies provide employees ample time before the termination of rights, a stock plan allows employees to compare their financial options and decide if the investment is suitable for them. After they are vested with the right, they may spend time analyzing the benefits of investing their hard-earned money in the company. Likewise, they may choose to invest in the company when the prices of the shares appreciate and they hold the privilege of purchasing shares at a fixed price. ESOP allows the employees to cautiously time their investment. Overall, a stock option plan provides its holder with a better chance to reduce investment costs, increase profit margins, and cash in on short-term gains.
How does an Option Scheme Benefit Businesses’ and their shareholders?
Shareholders and companies are interrelated in terms of their interests. When a stock option holder exercises their right, they become a part of the company shareholders through a Shareholder’s Agreement or Deed of Adherence. In that sense, the company, the shareholders, and the employees holding stock option plans can be observed as a singular entity due to their similarity of interests. Businesses and Shareholders enjoy the following benefits of having an ESOP for their employees:
1. ESOP increases employee productivity
Employees may not always have the incentive to be proactive in their workings in the company if they do not get additional benefits from their work. This may significantly reduce the efficiency of the company. Even efficient individuals may perform poorly when the company fails to employ correct motivational tactics. Having a stock option plan set within an enterprise provides multiple motivations to the employees. Employees who have exercised their vested rights and have ownership in the company directly benefit from the appreciation of the company value as they receive dividends from the profits. Employees with granted rights but who have not purchased shares in the company are incentivized to work for the increase in company value as the appreciation of the company value encourages them to invest in stocks. Employees who are not in the stock option pool hold the incentive to acquire an option plan in a company with an appreciating value. The overall augmentation in performance and productivity is advantageous to the shareholders and the company.
2. ESOP provides an exit means for retiring shareholders
The transaction of stocks can be risky for the company. Frequently, a company’s ownership is passed down generationally, and individuals are highly sceptical of trading stocks to a third party. A stock transaction entails the exchange of important and confidential information. For shareholders seeking to retire, handing over such data to a possible competitor is not preferable. Stock Ownership Options allow the transfer of company ownership to individuals who have proven their loyalty to the company’s objectives. This ensures that private information concerning the business is secured and does not leak through prospective buyers.
3. Tax benefits associated with ESOP
There are multiple tax advantages of an ESOP structure. Shareholders and companies enjoy tax deductions in the contributions they make to ESOPs. It is also very cost-efficient as corporations receive tax exemption for the portion owned by ESOP. Any loan taken to repay an ESOP contribution is not taxable. One of the many advantages of ESOP structures is that corporations do not tax employees for the contributions made by shareholders in the ESOP. ESOP is similar to a retirement account, where the employee only needs to pay taxes when they withdraw the money.
4. Incentivizing competent individuals to work for the company
ESOP agreements often have a period of vesting in which an employee loses their option if they leave the company too early. The vesting period provides employees with the motivation to stay longer in the company. It also allows the company to select an ESOP pool through which they can reward and promote work that is beneficial for the company. The opportunity to have ownership in a successful company is an enticing motivation to employees. Thus, ESOP helps companies retain their best employees for a longer period.
5. ESOP does not impact corporate governance
Change in governance does not impact the ESOP setting in a company and vice versa. Corporate Governance is not impacted by Stock Option Plans as employees that have not exercised their rights are not shareholders and do not have any voting powers that impact it. ESOP allows the company to increase its shareholders while maintaining relationships with its suppliers, distributors, or long-term clients. Changes and instability associated with new owners are not generated by Employee Stock Option Plans.
Employee Stock Option Plan allows companies to increase their employee’s productivity. It can be a safe method of sharing transactions within the company. Employees benefit largely from the tax advantages and the sense of belongingness associated with an ESOP. It is a very cost-efficient way of strengthening the company internally and aligning the interests of the shareholders with that of the employees.
You may also like:
- ESOP 101: Introduction to Employee Share Option Plans (Part 1 of 10)
- ESOP 101: Understanding Vesting, Exercise, and Expiration Terms Part-2
- ESOP 101: The Process to Set Up an Employee Share Option Scheme Part 3
- ESOP 101: Communicating and Administering an ESOP – Part 4
- ESOP 101: Tax Implications and Accounting of an ESOP Part 5
- What’s an ESOP and why might I need one?
- Employee Share Option Plan Template
- ESOP – Employee Acceptance Letter Template
- How to Set up your company option scheme?