For many business owners, determining the best path for sharing ownership and wealth with employees is an important long-term planning decision. Two common approaches are establishing an employee stock ownership plan (ESOP) and offering equity. While both involve granting a stake in the company, there are some key differences between these strategies.
An ESOP is an employee benefit plan that provides workers with an ownership interest in the company by distributing shares of stock. It functions much like a profit-sharing retirement plan, except the funds are invested primarily in the employer’s stock. Employees receive allocations of shares rather than cash contributions.
The ESOP trust owns the stock on behalf of employees. As workers accumulate more shares over time through additional allocations, they build equity and value as the share price increases. Employees can cash out the stock upon leaving the company. There are significant tax benefits for owners and employees with ESOPs.
Equity compensation provides employees with direct ownership in the company by granting them stock options, restricted stock units (RSUs), or actual shares. Equity serves as an incentive and reward for workers based on performance goals, tenure, or position. Employees benefit as the value of the company grows over time.
The main forms of equity plans are:
Stock options – Employees purchase company stock at a discounted price after the vesting period.
RSUs – Employees receive company shares as compensation but only take full ownership after vesting.
Direct stock awards – Employees are granted actual company stock, usually with certain restrictions.
While ESOPs and equity both increase employee ownership, there are some notable differences:
ESOPs are retirement plans while equity is a form of incentive compensation.
ESOPs purchase stock on behalf of employees as a group. Equity directly awards stock to individual employees.
ESOPs are more complex and regulated while equity plans are simpler and flexible.
ESOP contributions are tax deductible. Equity plans have more limited tax advantages.
ESOPs require majority ownership positions. Equity plans involve minority stakes.
Employees must be granted equity while ESOP participation is optional.
ESOPs payout upon leaving the company. Equity vests over time but can be exercised while employed.
Which is Right for Your Company?
Determining whether an ESOP or equity plan is more suitable depends on your goals, culture, and resources. ESOPs support retirement benefits and employee retention. Equity compensation incentivizes top performers. Some companies offer both ESOPs and equity for different purposes.
As you evaluate options, be sure to consult with financial and legal advisors to structure a plan that aligns with your objectives and complies with regulations. The path to increased employee ownership that best fits your organization can help drive growth, productivity, and shared success over the long-term.
To learn more about equity planning or ESOPs, contact our team of experts at Excel Legacy Group.