Esops As Employee Benefits

ESOPs as Employee Benefits

INDIRA WADHAWAN MBA-4544/07 TRAPTI SINGH CHAUHAN MBA-4033/07

ESOPs is not a generic term and is used for both Employee stock option plan Employee stock ownership plan (USA)

Employee Stock Options • reward top management and "key" employees and link their interests with those of the company • options are the most prominent form of individual equity compensation • A stock option gives an employee the right to buy a certain number of shares in the company at a fixed price "grant" for a certain number of years

• Allows employees to "cash in" by exercising (purchasing) the stock at the lower grant price and then selling the stock at the current market price • two principal kinds of stock option with unique rules and tax consequences:  incentive stock options (ISOs)  non-qualified stock options

Nonqualified Stock Options • number of types of options to purchase company stock that, does not satisfy the legal requirements to qualify as an ISO or a purchase plan option. • taxable to the employee at grant only if it has a readily ascertainable fair market value at that time, which nonqualified stock options almost never do. If it does not have such a value at grant, it is generally taxed at the time of exercise • the employer is able to give them a tangible reward for their efforts without using any liquid cash resources. As a result of the option, employees receive an opportunity to share in the future growth of the company.

• The regulations create an irrebuttable presumption that an untraded option does not have a readily ascertainable fair market value unless four conditions are met, including the following:  The option is transferable by the optionee.  The option is exercisable immediately in full by the optionee.  Neither the option nor the underlying property is subject to any restrictions that have a significant effect on the option's value.  The purchase fair market value of the option privilege is readily ascertainable. Therefore, almost all options for stock not actively traded will be deemed not to have a readily ascertainable fair market value.

PHANTOM EQUITY • best suited for executive plans • refers to plans such as phantom stock or stock appreciation rights (SARs) that provide employees with a payout, usually in cash, based on the increase in the company's stock value. • Employees may receive stock instead of cash, and phantom stock can include phantom dividends, etc., but the basic idea is a bonus based on the company's stock performance.

Employee Stock Ownership Plans • Equity based contribution benefit plan • Like profit sharing, an ESOP includes at least all full-time employees meeting certain age and service requirements. • Employees do not actually buy shares in an ESOP. Instead, the company contributes its own shares to the plan, contributes cash to buy its own stock (often from an existing owner), or, most commonly, has the plan borrow money to buy stock, with the company repaying the loan

How does ESOP work?

• The ESOP operates through a trust, setup by the company, that accepts tax deductible contributions from the company to purchase company stock. • The contributions made by the company are distributed to individual employee accounts within the trust. • The amount of stock each individual receives may vary according to pre-established formulas based on salary, service, or position. • The employees may ‘cash out’ after vesting in the program or when they leave the company depending on the vesting requirements.

• When an ESOP employee who has at least ten years of participation in the ESOP reaches age 55, he or she must be given the option of diversifying his/her ESOP account up to 25% of the value. This option continues until age sixty, at which time the employee has a one-time option to diversify up to 50% of his/her account. This requirement is applicable to ESOP shares allocated to employee's accounts after December 31, 1986. • Employees receive the vested portion of their accounts at either termination, disability, death, or retirement. These distributions may be made in a lump sum or in installments over a period of years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP accounts right away.

BENEFITS OF ESOPs • Benefits to sellers:  Opportunity for superior price  Potential continued relationships with the company  Reduced financial risk  Potential for tax advantaged sale proceeds  Opportunity for wealth creation

• Benefits to employees:  Improved relationships between employees and management  Favorable tax treatment compared to other benefit plans  Potential for wealth creation  Sense of company ownership for ESOP participants  Put option by law  Increased morale and loyalty  ESOP loan is non-recourse to employees  Retirement plan correlated with employee performance

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