ESOP Builders Inc. - Making Shared Ownership a Profitable Reality!

Our experience has allowed us to compile a list of questions from employees and owners about ESOPs. We have listed a sample of the most common questions below. We can provide a comprehensive list to all our ESOP clients.

1. What is a stock option?

2. What are the typical methods of allocating shares to employees?

3. How do you determine the value of the company and the shares?

4. Do ESOPs offer better compensation than other incentive plans?

5. How can employees cash out their shares?

1. What is a stock option?
A stock option is a right conferred by the company upon an employee to purchase shares of the company at a fixed price and up to a certain future date. Stock options are an accepted industry standard of compensation for employees because they reflect the ability of the employee to influence future growth and value of the company.

Generally, the employee will only exercise the option to buy a share when the share value is above the option exercise price. For example, the options would be exercised if the company went public, as the anticipated rise in the share value would result in a profit to the shareholder.

2. What are the typical methods of allocating shares to employees?
Generally accepted methods of allocating stock equity or stock options include salary or commission level, position (eg. executive, management, staff), years of service or a combination of these. There may also be other considerations which management may wish to include such as individual contribution and effort or results achieved.

3. How do you determine the value of the company and the shares?
A valuation of the company is necessary in order to determine the price at which the employees can buy or sell shares. Unlike a public company where the shares are traded every day on a stock exchange at whatever the value the market determines, private companies have no market in which to trade.

Consequently, a value known as the Fair Market Value (FMV) must be determined in another way. This can be done annually by an independent chartered business valuator for each fiscal year end. The value of a company lies in its potential to generate a return in the form of dividends and/or growth in share value. A number of factors are considered such as historic profit growth, future growth potential, market potential, management expertise, economic conditions, etc.

4. Do ESOPs offer better compensation than other incentive plans?
Many people consider shares in a fledgling private company to be a potentially valuable financial asset compared to shorter-term bonuses and profit sharing. Early stage companies may be undergoing rapid expansion with the longer-term goal of an Initial Public Offering (IPO). Consequently, employees who own stock in a private company that goes public can end up receiving a significant capital appreciation in their share value. Such was the case for employees in Microsoft.

5. How can employees cash out their shares?
The ESOP is designed to be a long-term plan, which rewards employees for remaining with the company. In general, most ESOPs allow for employees to sell their shares if the company goes public, is sold or merged or if the employee leaves the company. However, there would likely be different terms depending upon which scenario is followed.