What is an ESOP?

An ESOP is an Employee Stock Ownership Program. A company that decides to set up an ESOP for its employees is in essence setting up a trust for its employees to which it makes annual contributions. These contributions can be made in the form of money which is then converted to stocks, in the form of stocks contributed to the trust, either new or bought, or a combination of the two. Employees then are allocated their portion of the trust fund dependent on a number of different things.

ESOP allocation options

As a company offering its employees an ESOP, there are a number of different options that you have when it comes to allocating the contributions that you have made to the trust fund. Here are some of the most common allocation formulas used:

1. You can allocate compensation in proportion to the amount of compensation an employee receives.
2. You can allocate compensation based on years of service to the company.
3. You can allocate compensation based on a combination of years of service to the company and the compensation that is received.

Generally speaking, when ESOPs are set up, an employee can begin to receive allocated compensation after one full year of service to the company. During that year, the employee must have worked at least 1000 hours.

ESOP vesting

Before an employee can receive the shares of stocks and/or other assets that are allocated to them by the company, those assets must "vest." Vesting is the term used to describe a process where employees receive increasing percentages of their account as time goes on. An employee who has only been working for two years might not receive the full share of his or her entitled allocation for a few more years.

Here are the Top 10 rules that you should know about giving employees stock options under ESOPs:

1. The most conservative vesting plan must increase the percentage by 20% per year.
2. Under the most conservative vesting plan, an employee must receive his or her full share of assets after seven years with the company.
3. The above stipulations describe the slowest vesting plan allowed. Companies can move faster, if desired.
4. If an ESOP employee is:
   
   • 55 years old
   
   
   • has been with the company for at least 10 years
     he or she must be able to diversify his or her ESOP account for up to 25% of its value.

5. The above option stays in place until the age of 60, when the employee has a one-time option to diversify up to 50% of his or her ESOP account.
6. In the case of death, termination, retirement, or disability, employees receive the vested portion of their account.
   
   • This allocation can be done in installments or one lump sum.
7. In the case of disability or death, the account must be paid immediately to the employee or beneficiaries, in one lump sum.
8. If the company is public, then employees have the option to sell shares on the market.
9. If the company is private, then the employees have the option to sell the stock on the market for 60 days after distribution.
   
   • The company must offer one more option to sell period one year after distribution.
   
   
   • After the second option to sell period, the company has no more obligations in this wise.
10. 10. ESOP payments may be made under an "installment distribution" plan.


• Payments must be made in essentially equal amounts.


• Payment must be made of a period of time that begins:


• i. within one year for retirement distribution


• ii. within five years for pre-retirement distribution


• iii. cannot last more than five years


• adequate security must be provided and interest must be paid.