Eli5: What is an ESOP? And what exactly does “vesting” mean? What are the benefits AND consequences to employees with an ESOP benefit?
The company I’m at is introducing ESOP and it’s caused a whirlwind of opinions from coworkers. I tried to google it, but stocks and vesting are the one thing I could never grasp.
Thank you ☺️
In: 7
Someone else will have to give you the scoop on an Employee Stock Ownership Plan (i just googled it) but vesting is a required length of time until you become ENTITLED to a benefit.
So if i had to guess, your company is applying a vesting rule to either do some kind of company match and/or to let you keep the shares if you leave the company.
Ive seen “vesting” periods of 3 years or 5 years for “company match” dollar amounts when it comes to 401k.
It means if you leave the company before the X year “vesting” period, you are NOT vested (read: entitled/eligible) for whatever that extra benefit is (more shares, more money, etc).
Im sure they gave you SOME kind of information pertaining to what the vesting period is?
My wife worked for an ESOP company for 26 years. When she retired the payout on hers was over a 5 yr period. Each year the payment was based on how well the company was doing that year, either raising or lowering her payout. It was a healthy retirement. I worked for a 401k company for 20 years. Her retirement was 5 times that of mine.
ESOP means you can buy ‘shares’ in the company which means you are essentially a co-owner. At a minimum it typically means you’ll get a ‘dividend’ which is a small payment per share based on profit each year, and a vote in certain company decisions.
Your shares are typically only transferrable directly between you and the company. You cannot sell your shares to your parents, not can someone offer to buy them from you. This means the *value* of the stock, rather than being super tied to supply/demand is more like “what the company says it is”, which is a sort of big risk. I’d look into how these is done with your company, my company has a 3rd party do it for example.
Finally, you’ll probably hear about things called “RSU”s and get confused on an RSU vs a Stock share.
A stock is a thing you own and it can’t be taken from you. Since this is a private company if you ever stop working for them (quit, fired, laid off, etc) they will force a sale of the stock back and you’ll get paid. You can’t ‘not get paid’ the going value of the stock.
An RSU is a ‘promise’ of stock and it needs to ‘vest’ before it becomes stock, 3 years is the typical vesting cycle. So the company gives you 1 RSU today, nothing happens for 3 years on then on that future date 1 share of stock appears in your account. Three important notes
* Your RSU is a promise of *shares* not value. Let’s say the company stock is worth $1 and you get 10 RSUs, that’s $10 worth of stock right? If tomorrow the stock gets revised to $2 per share, you still have 10 RSUs, which is now worth $20! This means RSUs can be worth a lot more when they vest then you thought. If the stock shoots up to $100 per share your 10 shares become $1,000 when they vest. (or the opposite happens…)
* RSUs typically get dividends (annual payments to you) in the form of more stock, not cash. So if you have 10 shares and the dividend is $1 per share, you’ll get $10 worth of more stock. Again after 3 years this can mean your 10 share RSU can become a bunch more.
* If the company gives you $5, that’s taxable and you need to pay taxes. If they give 1 share of stock, *that’s* taxable and you pay taxes. RSUs, as a promise *are not* taxable. The moment they turn into stock though, is a taxable event, the same as if the company gave you a bonus that day. You should how your company will treat this. My company auto-sells enough of your RSUs/Stock to cover the tax bill and pays it for you.
Did that make any sense? My company went employee owned a decade ago and I’m fairly knowledgeable about it, DM if you have anything else.
It’s basically a contract between you and your employer where they agree to give you equity in return for some conditions you need to meet. The conditions might be that you need to stay at the company for a certain amount of time, or sacrifice some % of your salary, or something else (maybe a combination of both). The equity may be referred to as “restricted stock units” (RSUs), or ESOPs, or something else. The term ‘vesting’ describes when the conditions of the contract are met for the equity to actually become yours, this normally happens gradually over a period of time.
If the company is pre-IPO (not yet floated on the stock market) then even after vesting you won’t be able to sell your shares until there is an ‘exit event’, this is simply when the company is floated on the stock market or sold to new owners.
ESOP programs exist to motivate employees to stay at the company longer, and to improve their performance (since if **you** make the company do better, **your shares** will be worth more). It can also help the company reduce their salary costs if they offer part of their compensation as stocks.
IMO it exposes you to the risk of one company succeeding or failing. I prefer more diversification in retirement planning.
I worked for a publicly traded company with an ESOP. They purchased quarterly on the same day and the price spiked the day they purchased for the ESOP and sank back the next.
Esops are only good if it’s part of your compensation package and you don’t contribute your money to it. My company gives us 6% of our salary towards the esop yearly plus the leftovers where people not fully vested leave gets split evenly among the other members. It equates to a decent amount of money.
A lot of different ways / strategies for an ESOP to handle the benefit. My company has been an ESOP for about 30 years. First distribution was 35% of the shares in three years.
We moved to 100% in 2011 distributing the remaining shares over ten years. The DOL keeps a very close eye on any shenanigans, we have an external trustee who approves share value annually and works directly with a third party valuation firm. For us, the value is set annually.
We continue to have profit sharing, 401k match and will start a dividend process this year. The dividend will roll directly into the 401k and will be substantial.
Biggest issue with a successful ESOP for participants is the lack of diversity in a portfolio. We’ve had tremendous growth in our valuation due to success and the balance between our 401k and ESOP balances has become tilted too far into company balances. We will use an annual dividend to assist in the diversification and foster harvesting by vested participants.
An ESOP is a retirement plan. If you stay the idea is that you will have a nice retirement benefit. Government requires diversification windows to open for participants at 55 (a percentage of balance) and I think at 62 and 20 in our plan you can completely exercise a sale of all stock.
For us, the top shareholders are people and it is not tilted to just executives / upper management. I consider an ESOP very beneficial to those who are fortunate enough to be a part of one
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