ESOP 101: The Process to Set Up an Employee Share Option Scheme Part 3
By Joanne Hue, published: 2023-04-01
An Employee Stock Ownership Plan or ESOP is a benefit plan that provides employees of a company the option to own shares before the company they work for. Depending on the laws of the state, ESOPs tend to have tax benefits for their participants. ESOP is often observed as extremely lucrative for its participants, and companies set share option schemes to align the interests of the employees with that of its shareholders. The overlap in interest is said to increase company productivity.
In order to obtain loyalty from its employees for an extended period, ESOPs have a vesting period after which the employees can exercise their rights to purchase shares in the company until the expiration term has been reached. They are not obligated to purchase the shares, but they are incentivized by the lower rates provided by the agreement on the fixed exercise rates.
The process of setting an Employee Stock Option in your company is reliant on the laws of the country it is based in, the size of your company, and the size of the share option plan.
What is the cost of setting an ESOP?
The amalgamated cost of ESOP is generally lower than the profit it creates for the employees and the employers. As stated earlier, aligning the interests of the company and the employee can augment the productivity of the employees drastically. Aside from these clear benefits, business owners are also enticed to the setting of ESOPs due to their tax-efficient nature. Most plans do not charge income tax on employee options. This makes ESOP settings a cost-effective method to incentivize employees.
When employees exercise their option and purchase shares, they are only expected to lose 10% of their profits on tax. This is significantly less than the 45% income tax.
In recent years, the price of setting up option schemes for employees has reduced drastically- to the benefit of employers and employees alike. In the past, EMI schemes required the company to pay an amount ranging from £2500 to £5000. Nowadays, setting an ESOP plan requires companies to pay a flat fee of £1500. Overall, the advantages of share-option schemes for employees transcend their costs.
Process of setting up an ESOP
Setting an ESOP has become a convenient process due to technological developments. While it is a short process, companies need to take all the required steps prior to involving their employees in the scheme. The most crucial steps to setting an ESOP have been listed below:
1. Check the eligibility criteria
Prior to setting an Employee Stock Option Plan, you should ensure that your enterprise is eligible to set the scheme. You can get advice from legal practitioners in your state to understand laws concerning the setting of a share option in your company. Eligibility criteria vary vastly across countries contingent on the model and size of your business. In the UK, your business should have fewer than 250-full time employees to qualify for an EMI. Additionally, your company’s total assets should be below £30m and the company should not be controlled by or under any other company. Employees also have to fulfill certain qualifications to be eligible for this scheme. It is advisable for the company to conduct relevant research before setting up a share option scheme.
2. Structure your plan
ESOP schemes tend to be adaptable. It allows companies to alter their suits to the business needs. While structuring the option plan, companies need to consider the employees they seek to engage in the plan. They should consider the size of the shares along with the vesting period of the option. Since the provision of options to employees increases the probability of shareholders being added to the company, the companies should examine the impacts of share dilution on their existing shareholders.
3. Acquire approval from the company
Corporate authorization of the plan is obligatory. Once, the structure of the share option plan is completed, the company should approve it. The approval can be acquired in several ways, depending upon the structure of the company. You may require the approval of shareholders or the company’s board of directors.
4. Register the scheme
The country in which your business is based may have a process concerning the registration of the employee share option schemes. Acquiring official recognition is essential before engaging your employees in the scheme. In the UK, your company’s scheme must be registered with the HMRC. If your company is based in the UK, you can register your ESOP plan by visiting the government website and submitting an EMI notification. This needs to be done within 92 days after your grant date. Failure to do so might risk the tax benefits associated with the scheme.
Employee Share Option Plans provide large benefits to their participants. Employees can have an opportunity to purchase sarees in the company they work for at a price that is lower than the market value of their company’s shares. On top of that, they receive tax benefits with the scheme. Employers get to increase the company’s productive outcome by increasing the employee’s stakes in association with the company’s growth. The overlap of employee, shareholder, and company interests, creates a common objective for all the individuals associated with the company. Setting an ESOP has also become much more convenient as all the services concerning registration are available online. Hence, the benefits of ESOP outweigh its costs.
The process of setting an ESOP is dependent on the size and model of your enterprise. However, all business should verify their eligibility prior to setting up the scheme. They should structure and determine the size of the plan and the individuals they intend to involve in it. After the plan acquires corporate approval, they can officially register the scheme.
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
- 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?