Employee Stock Ownership Plan (ESOP): Meaning, How It Works, etc.

Employee Stock Ownership Plan (ESOP)

What’s the actual ESOP meaning? Well, It's known as an employee benefit plan. It provides all the workers with ownership within a company as shares of stock. ESOPs or Employee Stock Ownership Plans will offer the sponsoring company participants and selling shareholders countless tax benefits.

Published on 30 January 2023

It also provides them with qualified plans that employers utilize in the form of corporate finance tactics to merge the employee's interests with the shareholders. To learn ‘what is ESOP’ in detail, along with its benefits and importance, this article will help you.

ESOP: How Exactly Does It Work?

Once you know the ESOP meaning, you also need to learn how exactly it works. The Employee Stock Ownership Plan is designed to facilitate succession planning within an enterprise. It's done by enabling all the employees to purchase the company shares in the form of stock.

The ESOP shares are set as "trust funds" and can be easily utilized by businesses by placing new issues shared into them. It can also be done by borrowing funds from an entity to purchase company shares or purchasing current business shares.

ESOP is utilized by businesses of all sizes, including the big publicly traded enterprises. Apart from what people say, a business that has ESOPs should not discriminate and must appoint a trustee to play the part of the plan fiduciary.

Actual ESOP meaning in share market, is that senior employees will not get more shares or the ESOP participants will not have any voting rights.

The Advantages of ESOP

Just like knowing the ESOP meaning is important, learning about the benefits you will get is also crucial. So, what are these benefits? Let's find out.

1.    The Stock Ownership

The actual ESOP meaning is to offer ownership to all the employees of a business where they work. It's because the Employee Stock Ownership Plan provides the right to own a part of the business's share capital.

2.    Purchase Share at a Discounted Rate

When exercising the ESOPs, all employees should pay a nominal amount to purchase the company shares allotted to them. This enables them to invest in the business at a preferential rate.

3.    Dividend Income

Part of the profit earned by the business gets divided among all the shareholders as dividends. Employees can also earn extra dividend income and receive a direct advantage from all the efforts they put into the profitability of the business.

4.    The Employee Retention

As employees need to wait out of the vesting period right before they can opt for their ESOP, it will become much easier to retain all the employees.

5.    Excellent Productivity

As employees can stand to gain from all the profits that the business has earned, the ESOPs can easily boost employee productivity and also make the business a lot more profitable.

6.    A Great Tool for Pulling in Talent

When you talk about ESOP meaning, it's known as extra plans that will help all employers to retain and attract all talented employees. For all the start-ups out there, ESOP can easily pull in excellent talents during the initial days when all the high packages are not that feasible.

How Can You Cash Out the ESOPs?

Being vested does not mean that you can cash out the ESOP. In general, it's only possible to obtain all these shares when you become disabled, die, retire or terminate your employment.

Age also is a crucial factor here. It's because the distribution of the ESOPs is rarely provided to individuals below 59 or 55 when employment gets terminated.

Even if permitted, they can only cash out a 10% early withdrawal penalty. You can find crucial information in the terms which are listed in the ESOP's guidelines. It also carries information on how you can cash out the ESOPs.

Employee Stock Ownership Plan: An Example

The best way to understand the ESOP meaning is through an example:

"Suppose an employee has worked for a big tech company for 5 years. Under the firm's ESOP, they will get 20 shares after the 1st year and 100 shares after 5 years. So, when the employee retires from the company, they will get the share value in the form of cash."

The stock ownership plan will also contain stock appreciation rights, stock options, restricted shares, and many other things.


ESOPs are viewed as a win-win for all employers and employees. It encourages much greater commitment and effort in exchange for massive monetary rewards. But these ESOPs are not always simple and can be pretty frustrating when the participants need help understanding the terms of the plans.

But remember one thing, all ESOPs are not created the same. The rules on the actions, such as withdrawal and vesting, can differ greatly. That's why it's important to stay well aware of them so that you can make a great amount of benefit and take advantage of any bonus.

Chandresh Khona
Team Espresso

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