ESOPS

Another growing concern in the employment area is that of compensation by stock. Not only are executives receiving stock options as part of their compensation, but also employees are receiving compensation in the form of equity ownership. Detailed provisions govern stock options and employee equity ownership plans.

The rest of this section discusses provisions providing part of an employee's compensation in the form of equity (stock). These are know as Employee Stock Ownership Plans (ESOPS). They are almost exclusively a product of federal tax law, tax laws passed from 1974 to 1986, tax laws with very great incentives. Several decades ago, Congress passed laws to promote the general policy of having ownership of capital more widely distributed and to encourage productivity. It passed laws offering businesses tax incentives if the greater part of the business's employees were paid part of their compensation in stock ownership of the company. Whether the policy is a good one and whether the tax law is effective is a debated issue. Employee Ownership: Revolution or Ripoff?, Blasi, Harper Business, is a readable account of the policy debate.

In general, an ESOP is a trust account created by a company. The company places money in the trust, either borrowed or cash reserves, and the trust purchases stock of the company from the company, and the company receives a federal tax break. (Note: The company gets to use the money in the trust since the money is used to purchase its own stock - the trust cannot invest elsewhere.) The employee can only sell his stock when he leaves or retires. There are three types of ESOPs.

The Nonleveraged ESOP: The company borrows nothing, but distributes stock from cash or stock on hand. When the employee retires, he cashes out the value of the stock he owns.

The Leveraged ESOP: The company borrows money to create a trust. Trust buys stock in the company and distributes to employees. The company receives a tax break for paying down the money borrowed for the trust.

The Tax-Credit ESOP: In this little used large, publicly-traded company version, the company does not borrow money but distributes stock to employees in return for a tax break up to a certain amount.

Since ESOPs are a creature of taxes, companies without significant income, such as startups, have no great incentive to create them other than employee morale reasons. However, in the 1980s, high-tech startups often offered ESOPs especially when profitable. As you can see, knowledgeable financial advisors are essential in setting up an ESOP.

Benefits of an ESOP for the small, privately-held company include:

• Used as a succession plan for the family business
• Used as an estate planning tool
• Creates a ready market for retiring workers's stock who want to covert their stock into cash
• Avoids post-death liquidity problems of substantial stockholders
• Employee motivational tool
• Used as a means to enhance the amount of cash available to the company to work with.

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