Employee Share Ownership Plans (ESOPs) are schemes implemented by businesses to allow their employees to acquire company shares. They can also be a specific portion of shares.
Employee shares are particularly valuable because they have a future value, unlike other kinds of stock. The price at which these employee-owned shares may be sold is called the exercise price, and it lasts for a certain period known as the exercise period.
Read on to find out more about ESOPs (Employee Stock Ownership Plans) and their operation.
Why Are ESOPs so widely used?
As previously stated, the exercise period allows employees to utilize or not use their gifted employee stock options at a price determined by the firm at the time of grant. It’s important to note that this is simply a choice, and not mandatory. In addition to this, a company decides the size of the option pool, there is no one rule.
What does this mean for individuals wanting to exercise their rights?
From the viewpoint of an employee, they anticipate making a profit representing the gap between the company’s future value and the exercise price. Organisations see this as a useful tactic to reward and encourage key and committed employees to stick with the company, by giving them equity shares in exchange for any future growth in profits.
Employee stock ownership plans are an alternative way to motivate and encourage top workers and high performers. Rather than offering higher salaries and remuneration, private companies implement employee stock options. Therefore, ESOPs are commonly implemented by new businesses in their establishment stage that are low on financial resources.
Employee Stock Ownership Plans may be divided into one or more vesting period categories. It’s important to know that there is a typical practice of imposing a one-year cliff during which the option cannot be exercised (this is meant to give both the business and employee enough time to determine whether they want to continue with their mutual agreement for a longer period).
Who can use ESOPs?
It’s important to note that an Employee Stock Ownership Plan does not only apply to staff. It may also be given to directors, officers, and consultants. If a company’s potential is obvious, these individuals might also benefit from the choice.
Advantages of ESOP
The two perspectives we will look at below are employee vs company benefits.
Employees benefit from an Employee Stock Ownership Plan since company contributions are made every year including both cash and stock.
These benefits are allocated to the accounts of participating employees in the trust created as part of the Employee Stock Ownership Plan. The accumulated balance in a participant’s account is distributed to the participants following their retirement or other forms of employment termination.
The ESOP benefits account, on the other hand, is not taxable to the employee as long as it stays in the ESOP trust.
On the one hand, an ESOP may help a firm by providing funding as well as employee benefits.
Corporate ESOP benefits cover:
- Raising additional equity capital
- Refinancing owing debt
- Using cash borrowed from third-party lenders to get resources that will generate income.
ESOPs can be utilised to improve cash flow by making plan contributions in company stock rather than currency. A firm may use pre-tax money to pay both the principal and ownership interest on an ESOP debt service since the ESOP contributions are fully tax deductible.
It’s important to note that dividends paid out by an ESOP are tax-deductible if they are used to repay the ESOP loan principal – the funds of which were used to acquire the employer securities regarding the dividends paid.
Common Questions
Lastly, we’ll address some of the most frequently asked questions and concerns about ESOPs.
What are the option pool sizes?
The option pool is not defined by any general guideline. However, in most situations, the option pool ranges from 8% to 20%.
How is ESOP monitored in Hong Kong?
If we look at this problem from a practical standpoint, the Employee Stock Ownership Plan may be compared to selling stocks. The Companies Ordinance, enacted in 2014, regulates the issuing and sale of securities to Hong Kong investors.
However, ESOPs fall into a category that is exempt from regulation, and there is no requirement or restriction in place to limit the offer of securities to these four classes of beneficiaries (employees, directors, officers, and consultants).
How is tax handled for ESOP in Hong Kong?
You might be relieved to hear that there is no tax charged when you grant a stock option plan like this one. One of the greatest financial advantages in Hong Kong is that there is no tax on the grant of stock. However, if an employee uses the option, both the employer and the employee are obligated to report this amount to the Inland Revenue Department for tax purposes.
Fortunately, the ESOP is not regarded as a source of taxable income for MPF purposes. However, keep in mind that employees who exercise their ESOP option may be subject to tax on their wages in foreign countries.
How do I set up an ESOP?
The ESOP must be adopted at the shareholder level during the annual general meeting to accomplish this. It must also be approved by the board of directors. After the plan is implemented, an Option Certificate will be issued.
This certificate establishes the rules and regulations for Employee Stock Ownership Plans. When investors make a clear commitment that the executive team will be adequately funded, an ESOP is generally established on a first or second round of investments.
Summary
The Employee Ownership Program, on the other hand, can provide significant advantages to both businesses and employees. Although many organisations in various countries (including Hong Kong) are hesitant to implement employee stock-ownership plans, more and more firms are recognising the advantages of ESOPs.
You should strongly consider providing these kinds of plans since more and more professionals consider firms that don’t provide them less appealing to work for.
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