What is Employee Stock Ownership? Understanding ESOPs & ESOs

An employment contract should be treated more than just fulfilling statutory requirements. You must innovate over existing incentives and think beyond flexible work arrangements for a successful working relationship over time. 

You can overcome workforce challenges by internalizing the employee stock ownership definition and giving your employees a greater sense of ownership and involvement in the company's success. 

Fortunately, we have it sorted out for you. In this article, we will define employee stock ownership plan, discuss what is an employee stock option, shed light on employee stock ownership plan vs employee stock option plan, and discover how they can benefit your business. 

Understanding Employee Stock Ownership

Employee stock ownership refers to providing employees with shares and creating an ownership culture within your company.

In the U.S., the definition of employee stock ownership involves employee stock ownership plans (ESOP). 

You can use ESOPs as a part of employee retirement plans, in addition to a 401(k) plan, or simply to reward and engage their employees. 

Alternatively, the employee stock ownership definition also includes equity compensation plans that link employee compensation to company performance. 

Both approaches often result in better employee retention, motivation, and job satisfaction because they feel directly invested in your company’s success. 

Let’s explore them further and start by looking at ESOP meaning.

What is an ESOP (Employee Stock Ownership Plan Definition)?

An employee stock ownership plan is a retirement benefit plan that allows you to give your employees a stake in your company. 

You can keep them more aligned with your company’s mission and goals through the following types of employee stock ownership plans in the U.S., including:

• Traditional ESOPs: You can establish a trust fund that holds shares of your company's stock, which will transfer to your employees over time. 
• Leveraged ESOPs: In this setup, the ESOP trust secures a loan to purchase company stock, and you contribute to the ESOP to help repay that loan. You can utilize this approach to raise capital without diluting control.

What is ESOP distribution?

ESOP distribution is nothing but employee stock ownership plan rules for disbursing your employees’ accumulated ESOP retirement benefits. 

Moreover, you don’t have to immediately transfer shares under the employee stock ownership plans. 

You can have a vesting period under the ESOP plan before your employees can access their ESOP shares based on factors like years of service, etc.

The employee stock ownership plan withdrawal process allows employees to access their accumulated shares in the company, usually when they retire, leave the company, or meet specific plan conditions. 

Employee stock ownership plan pros and cons

ESOPs can be a valuable tool for transitioning ownership to employees. 

Here is a quick summary of employee stock ownership plan advantages and disadvantages before deciding if it is the right choice for your organization:

Pros of ESOPs

• You can attract and retain top talent, especially in competitive industries.
• Your employees may work harder and more efficiently, knowing their efforts directly impact their financial future.
• You may receive tax deductions for contributions to the ESOP trust.

Cons of ESOPs

• Existing shareholders may see their ownership stake diluted as more shares are issued to employees.
• Employees' financial well-being is tied to the company's performance. A decline in stock price can negatively impact their net worth.
• Employees may have difficulty selling their shares, especially in private companies.
• Setting up and managing an ESOP can be complex and costly.

If you’re thinking - ‘how do employee stock options work’, here’s your answer.

What is an ESO (Employee Stock Option)?

An Employee Stock Option (ESO) enables employees to purchase company shares at an exercise price. 

This pre-determined price allows employees to buy shares at a fixed rate anytime, regardless of the market price fluctuations. 

You can utilize such an employee share option plan as a performance-based incentive to motivate your employees to contribute to the company's success. 

It is merely an equity compensation option and not an obligation on employees to purchase.

In the U.S., you can make use of the following types of employee stock options:

• Direct Stock Purchase Plans: Though not technically an ESOP, DSPPs offer employees ownership options similar to ESOPs. This plan allows employees to buy shares directly rather than having them awarded.
• Phantom Stock Plans: Instead of granting real company shares, you can offer a cash bonus that mimics the current value of company stock. 
• Stock Appreciation Rights: You can compensate employees equal to the increase in stock price over a set period without granting actual shares to employees. 

How are employee stock options taxed?

Your employees are concerned about checking how stock options work and are taxed. 

Employee stock options (ESOs) are generally taxed in two stages in the U.S.:

1. When employees exercise their stock options (buy shares at a set price), any difference between the exercise price and the fair market value is considered income.
   • Alternatively, when stock options are not taxed at exercise, they may be subject to the Alternative Minimum Tax (AMT).
2. Employees who sell the shares acquired through ESOs may pay capital gains tax on any profit.

The Benefits of Employee Stock Ownership for Companies

Employee experience is an overarching factor in managing global teams. You will experience significant improvements in overall employee satisfaction by passing on the benefits of employee stock ownership plans and employee stock options, including:

• Employees who own a stake in your company are likelier to stay, enabling a stable, long-term workforce and reducing turnover costs.
• Giving employees a share of the company’s success directly improves productivity and overall performance.
• Employee ownership aligns your team with company goals, increasing their sense of responsibility and dedication to helping the business succeed.

Tax and financial advantages for businesses

Offering employee stock ownership can bring significant financial and tax benefits like:

• ESOP contributions are often tax-deductible, helping reduce your company’s tax liability and freeing up funds for growth. 

Explore our Tax Identification Number article (TIN) for U.S. and Foreign Persons to understand tax identification processes in the U.S.

• Compensating with stock options allows you to provide competitive incentives without immediate cash outflow, thereby creating more capital for operational needs.

How Employee Ownership Impacts Employee Engagement and Retention

When employees see the potential for financial gain through rising stock prices, they are more likely to be engaged and committed to achieving their company goals.

In the U.S. alone, nearly 6,500 companies claim employee stock ownership plan benefits, covering around 14 million employees. 

The NCEO findings revealed that ESOP food companies had lower quit rates and were more likely to report increased revenues during the recent pandemic. 

The benefits of ESOP for employees resulted in a sense of ownership, and financial incentives drove increased job satisfaction and loyalty. 

They performed better in crisis response. Notable employee stock ownership plan include those from major supermarket chains like Publix and Winco.

ESOP vs. ESO: Understanding the Two Most Common Forms of Employee Stock Ownership

Employee ownership can take various forms, the most common being Employee Stock Ownership Plans (ESOPs) and Employee Stock Options (ESOs). 

Below is a comparison between employee stock ownership plan vs. stock options to help you understand their key distinctions:

Why Employee Ownership Matters in Today’s Workplace

Employee retention has become a significant challenge in today’s global job market. 

Your employees are increasingly seeking more than just competitive salaries and statutory benefits; they are looking for a sense of belonging, purpose, and ownership in your organization. 

In this context, the employee stock ownership definition has evolved into a powerful, cost-effective strategy for addressing retention challenges and creating a more engaged workforce. 

There are thousands of case studies on how employee ownership directly changed workforce culture and increased revenue for numerous SaaS companies. 

Salesforce’s success over the years is an impactful employee stock options example, reflecting a strong company culture and employee-centric policies that directly contributed to the revenue growth. 

How Skuad Can Help You Hire, Pay, and Manage Employees Globally

Looking to expand your team globally and stay cost-effective? 

Skuad can help you hire, pay, and manage employees in over 160 countries compliantly. 

Moreover, Skuad simplifies employee management with services that cover every step - from onboarding to payroll - ensuring your team stays connected and productive across borders.

Whether you’re looking to offer attractive employee stock ownership benefits like ESOPs or ESOs to drive engagement, Skuad can provide the expertise and tools you need to manage these options effectively and compliantly. 

Ready to scale your global team? Let's talk. 

Book a demo to continue! 

FAQs

1) What is the meaning of employee stock ownership?

Employee stock ownership is a reward system that may involve granting ownership stakes in the company. Common stock ownership tools include Employee Stock Ownership Plans (ESOP) and Employee Stock Options (ESO).

2) What is an example of employee stock ownership?

Top examples of employee stock ownership include ESOP and ESO. 

Here’s an Employee Stock Ownership Plan example (ESOP), employees receive stocks over time, whereas under an Employee Stock Option (ESO), they have the right to exercise their allotted share at a fixed price. 

3) What are the benefits of employee stock ownership?

The benefits of ESOP for employees include instilling a sense of ownership, increased motivation among employees, and financial gains. 

Moreover, ESOPs are tools to attract top talent and align employee interests with company goals. Furthermore, employee stock ownership plans offer tax advantages for long-term growth.

4) What is an employee stock ownership plan for dummies?

An employee stock ownership plan is a workforce enhancement strategy. It makes employees part owners. This will make them more invested in and committed to the company’s success. 

You can contact Skuad to manage ESOP or ESO compliantly in over 160 countries. 

5) How do I cash out my ESOP after I quit?

The cash out of an ESOP depends on the withdrawal plan set by the company when the pool is formed. Typically, the ESOP withdrawal is linked to employees’ tenure or when they retire. 

6) How does an ESOP work?

To define ESOP, it works by creating a managing trust that buys company stock. This stock is then allocated to employees over time, often based on their years of service and compensation. At that point, the employees can sell their shares or keep them as investments.