ESOPs (Employee Stock Ownership Plans) have been around in some form since the 1920s. In the early 1970s, ESOPs were awarded special tax considerations, and as a result they have become the most common stock-option plan, according to the National Center for Employee Ownership.

Heres how an ESOP works: An eligible company opens a trust fund, contributes cash or its own stock shares, then allocates shares to employees in increments based on pay rate or other factors. These shares may become vested over time as the employee gains seniority within the company; the vestment can accrue gradually over three to six years or all at once after a certain amount of time has passed, which is known as cliff vesting.

Employees who own shares may vote on major company issues, although the company can bypass an employee vote on smaller issues by going straight to the board of directors. Private companies must receive an annual outside valuation to determine share price. And when a stock-owning employee quits a private company, the organization must buy back the employees stock for its fair market value.

The contributions companies make to these plans are tax-deductible. Additionally, ESOPs allow companies to borrow money in order to purchase shares. Contributions to repay the loans are also tax-deductible, meaning both the principal and interest go untaxed. Because of these special considerations, however, not all companies are allowed to participate in ESOPs, and others are allowed to participate only under certain restrictions.

Private companies may especially benefit from ESOPs, since the plan may open up a market for its shares. There are no strict limits on the size of a company that can participate, but ESOPs work best for organizations with more than 20 employees.

Alternatives to ESOPs

Offering an ESOP is not right for every company. In certain cases, such as most professional corporations and partnerships, ESOPs cannot be used; in other kinds of corporations, limits and restrictions may apply.

If your organization does not qualify to offer an ESOP or cannot apply the tax benefits, you may wish to offer a different kind of employee ownership plan. There are many variations, but here are some of the most common:

• Stock options Employees may buy shares of stock at a set price, during a specified time period, once the option has vested. If an employee is given the option to buy shares and the stock price increases, the employee can sell his or her shares on the market at a profit. If the price decreases, he or she does not have to exercise the stock options. Companies need not offer stock to all employees.

• Individual equity There are several other kinds of individual equity plans, each with particular rules and restrictions. Here are a few:

• Restricted stock Employees who meet certain restrictions can acquire shares at a fair or discounted value.
• Phantom stock Employees might earn a future cash or share bonus equal to the value of a certain number of shares.
• Stock appreciation rights Employees can be given the right to the increase in value of a certain number of shares, paid either in cash or in shares.
• Stock awards (performance shares) Employers give shares directly to employees if they meet certain performance criteria.

Evaluating the Costs and Benefits

Before settling on a stock plan, employers should weigh the costs and benefits to determine whether the proposed plan can benefit both its staff and the parent company. Implementation and administration costs will vary greatly from company to company and plan to plan. Still, you can begin to draw up an estimate by considering the following expenses:

• Fees for preparing documents and government filings.
• Initial valuing of the stock shares.
• Yearly revaluations of stock price.
• Administration costs for staff time and data archives.
• Fees for the lenders counsel, documents, financial consulting and loan-commitment fees.

Keep in mind, however, that money is just one consideration. Offering employees part ownership in a company can provide an attractive supplement to an employees compensation package. Also, having part ownership in the companys performance will motivate many employees to work their hardest and perform at their peak. For many companies, this kind of loyalty is invaluable.