How to Choose an Employee Stock Plan for Your Company (from www.nceo.org)

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How to Choose an Employee Stock Plan for Your Company


Many companies we encounter have a pretty good idea of what kind of
employee ownership plan they want to use, usually based on specific
needs and goals. However, sometimes they might be better served by
another kind of stock plan. And yet others say they'd like to have an
employee ownership plan, but they're not sure what it might be. This
article will start you down the path to choosing and implementing the
plan or plans best suited to your company.


Plans for Broad-Based Employee Ownership


Let
us begin by quickly reviewing the main possibilities for broad-based
employee ownership. A "broad-based" plan is one in which most or all
employees can participate. (Note to non-U.S. readers: like everything
else on this site, this is U.S.-specific.)



  • An employee stock ownership plan (ESOP)
    is a type of tax-qualified employee benefit plan in which most or all
    of the assets are invested in stock of the employer. Like profit
    sharing and 401(k) plans, which are governed by many of the same laws,
    an ESOP generally must include 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. All of these uses have significant tax
    benefits for the company, the employees, and the sellers. Employees
    gradually vest in their accounts and receive their benefits when they
    leave the company (although there may be distributions prior to that).
    Close to 12 million employees in over 11,000 companies, mostly closely
    held, participate in ESOPs.

  • A stock option plan grants
    employees the right to buy company stock at a specified price during a
    specified period once the option has vested. So if an employee gets an
    option on 100 shares at $10 and the stock price goes up to $20, the
    employee can "exercise" the option and buy those 100 shares at $10
    each, sell them on the market for $20 each, and pocket the difference.
    But if the stock price never rises above the option price, the employee
    will simply not exercise the option. Stock options can be given to as
    few or as few employees as you wish. About nine million employees in
    thousands of companies, both public and private, presently hold stock
    options.

  • Other forms of individual equity plans:
    Restricted stock gives employees the right to acquire shares, by gift
    or purchase at a fair value of discounted value. They can only take
    possession of the shares, however, once certain restrictions, usually a
    vesting requirement, are met. Phantom stock pays a future cash or share
    bonus equal to the value of a certain number of shares. When phantom
    stock awards are settled in the form of stock, they are called
    restricted stock units. Stock appreciation rights provide the right to
    the increase in the value of a designated number of shares, usually
    paid in cash, but occasionally settled in shares (this is called a
    "stock-settled SAR"). Stock awards are direct grants of shares to
    employees. In some cases, these shares are granted only if certain
    performance conditions (corporate, group, or individual) are met. These
    awards are usually called performance shares.

  • An employee stock purchase plan (ESPP)
    is a little like a stock option plan. It gives employees the chance to
    buy stock, usually through payroll deductions over a 3- to 27-month
    "offering period." The price is usually discounted up to 15% from the
    market price. Frequently, employees can choose to buy stock at a
    discount from the lower of the price either at the beginning or the end
    of the ESPP offering period, which can increase the discount still
    further. As with a stock option, after acquiring the stock the employee
    can sell it for a quick profit or hold onto it for awhile. Unlike stock
    options, the discounted price built into most ESPPs means that
    employees can profit even if the stock price has gone down since the
    grant date. Companies usually set up ESPPs as tax-qualified "Section
    423" plans, which means that almost all full-time employees with 2
    years or more of service must be allowed to participate (although in
    practice, many choose not to). Many millions of employees, almost
    always in public companies, are in ESPPs.

  • A Section 401(k) plan
    is a retirement plan that, unlike an ESOP, is designed to provide the
    employee with a diversified portfolio of investments. Like an ESOP,
    however, a 401(k) plan is a tax-qualified plan that generally must
    include all full-time employees meeting age and service requirements.
    The employees can choose among several or more choices for investments,
    and the company may make a matching contribution. Perhaps several
    million employees in a few thousand companies participate in plans with
    a heavy company stock component; company stock may be an investment
    choice for the employees and/or the means by which the company makes
    matching contributions. 401(k) plans may be combined with ESOPs (these
    are called "KSOPs"), where the company match is an ESOP contribution.


Remember...


ESOPs Are Not Options


People
who are familiar with stock options and encounter the word "ESOP"
sometimes think it means "Employee Stock Option Plan," but it means
nothing of the sort, as explained above. ESOPs and options are totally
different. Neither is "ESOP" a generic term for an employee stock plan;
it has a very specific legal definition. (Outside the U.S., "ESOP"
means various things, ranging from U.S. ESOP-like plans to stock option
plans.)


"Incentive Stock Option" Is Not a Generic Term


Another
common misconception is that "incentive stock option" is a general term
for stock options given as an incentive to employees, etc. Actually,
the incentive stock option is one of two types of compensatory stock
options (the other type is the nonqualified stock option), and it has
very specific legal requirements.


Typical Situations


Having covered the plans you might use, let us see where they fit into typical corporate situations:


Private (Closely Held) Companies



  1. Companies that plan to go public or be acquired (high-tech startups, etc.):
    Despite all the stock market and accounting rule changes that have
    occurred over the last decade, options are still the currency of choice
    when it comes to attracting and retaining good employees; many
    high-tech workers won't take a job without options. As the company is
    going public, it is common to put a stock purchase plan in place as
    well. There is growing interest, however, in stock appreciation rights
    and restricted stock as well.

  2. Closely held companies with owners looking to sell some or all of their stock:
    An ESOP is usually the best choice. In most cases, the ESOP will borrow
    money to buy out the shares, but the company may just put in more...http://www.nceo.org/main/article.php/id/5/


Public Companies


In
some ways, public companies have more flexibility when choosing a stock
plan, since (1) there is a market for the stock, thus meaning the
company doesn't have to buy it back from employees; (2) there are no
securities issues since the stock is already registered, and (3) they
typically have larger budgets than private companies, some of which,
for example, balk at paying the hefty sums associated with setting up
an ESOP. Thus, the selection process has less to more...http://www.nceo.org/main/article.php/id/5/


Very Small Private Companies on a Budget


What if your
company is very small (maybe 7 or 10 employees), plans to stay that
way, and the cost of setting up an ESOP or even a 401(k) plan seems
prohibitive? There is no easy answer for you; perhaps a yearly cash
bonus based on company performance would be better than a stock plan.
You might read our Conceptual Guide to Employee Ownership for Very Small Businesses for more ideas and a general grounding in the issues.


Synthetic Equity


"Synthetic
equity" 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; in the case of phantom stock settled in
shares, this is usually referred to as a restricted stock unit plan.

Synthetic
equity plans are relatively easy to create and maintain, and they are
generally not subject to securities laws. The underlying stock still
must be valued more...http://www.nceo.org/main/article.php/id/5/


Where to Go from Here


An article like
this can only scratch the surface of a complicated subject. The
suggestions made here are only suggestions, and may not fit your
particular situation—that's why the heading above reads "Typical
Situations." It is essential that you educate yourself further and, if
you set up a plan, hire the right people to help you.


Further Reading



Personal Advice and Suggestions


If
you are an NCEO member or if you join, you can call or email with
questions or just to have a general discussion. We always suggest that
members who are deciding which plan(s) to use consult with our
executive director, Corey Rosen. Also, you can hire us to speak to your
company or provide introductory consulting.


Hiring Service Providers to Set Up Your Plan


It
is crucial not only that you be well informed but also that you hire
experienced, qualified, and ethical professionals. NCEO members have
access to the members' area of this site, where they can read extensive
advice on who they need to hire and how to hire them, and then search
our database of 250-some service providers.


And Don't Forget...


An
employee stock plan may mean very little to employees unless you
communicate it well! As you explore what we have to offer, don't miss
our resources on communicating plans to employees (such as our
publications on communicating equity compensation and The ESOP Communications Sourcebook, plus our meetings on communicating to employees) as well as our ownership culture resources.


 


more...http://www.nceo.org/main/article.php/id/5/

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