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Building a Culture of Ownership: Discovering the Types of ESOPs

by Costi Milchi • July 24, 2023 • 4 minute read

Employee ownership has gained significant popularity in recent years as a way to empower and motivate employees while aligning their interests with the success of the company. One of the most common mechanisms for achieving this is through Employee Stock Ownership Plans (ESOPs). In this article, we'll explore the world of ESOPs in Europe, trying to understand their types, common features, and the advantages and disadvantages of Share ESOPs and Option ESOPs.  

What is an ESOP?

Before we dive into the different types of ESOPs, let's first understand what an ESOP actually is. ESOP, short for Employee Stock Ownership Plan, is a mechanism that allows employees to become partial owners of the company they work for. It typically involves providing eligible employees with shares or stock options, which they can acquire, often at a discounted price or as part of their compensation package. This ownership stake enables employees to benefit from the company's growth and success, creating in the same time a sense of ownership, loyalty, and dedication.

In our article, we will call generically ESOP any plan that gives employees the possibility to become owners in the company, either directly, through receiving shares, or indirectly, by receiving options that could be transformed into shares.

Could employees receive shares in other ways than ESOPs?

While ESOPs are a popular means of employee ownership, they're not the only way employees can receive shares in a company. Some organizations offer direct stock purchase plans, where employees can buy company shares at market prices. Others provide restricted stock units (RSUs), which grant employees shares that vest over time. Additionally, stock bonus plans and stock appreciation rights (SARs) are alternative methods to grant employees a stake in the company's success. However, for the purpose of this article, we'll primarily focus on the different types of ESOPs prevalent in Europe.

Which are the typical types of ESOPs used in Europe?

ESOPs come in various flavours, each designed to cater to different organisational needs and employee preferences. Let's explore the three most common types of ESOPs found in Europe:

1. Share ESOPs:

Share ESOPs, also known as Stock Purchase Plans (SPPs), are the most straightforward type of ESOP. They allow employees to purchase company shares directly at a discounted price. Typically, the shares are bought using employees' own funds, either through regular payroll deductions or lump-sum payments. Share ESOPs offer employees a tangible ownership stake, making them feel like true company partners. As an added bonus, employees may also receive dividends on their shares, further enhancing their sense of ownership and reward.

2. Option ESOPs:

Opt ESOPs, also called Stock Option Plans (SOPs), provide employees with the right to purchase company shares at a predetermined price within a specified timeframe. These options have an exercise price, often set at the current market value of the shares at the time of grant. Employees can exercise their options after a certain vesting period, typically incentivizing them to stay with the company to reap the benefits. Option ESOPs are an excellent tool for aligning employee interests with long-term company success.

3. “Phantom Shares” ESOPs:

Don’t be afraid, there are no phantoms involved in this type of ESOP. An ESOP with phantom shares is a variation of an Employee Stock Ownership Plan (ESOP) that provides employees with virtual or "phantom" shares rather than actual ownership in the company.  

In an ESOP with phantom shares, employees are granted hypothetical units or shares that mirror the value of actual company shares. These phantom shares simulate ownership and provide employees with similar financial benefits without actually owning the underlying shares.

Similar to traditional ESOPs, phantom share plans often include vesting periods during which employees must fulfill certain conditions, such as remaining with the company for a specific duration, to become eligible for the full value of the phantom shares. Once vested, employees may receive payouts in cash or stock based on the value of their vested phantom shares.

It's important to note that employees with phantom shares do not possess actual ownership rights or voting power in the company. Phantom shares are purely financial instruments designed to provide employees with economic benefits tied to the company's performance.

Which are the common things for all ESOPs?

While each type of ESOP has its unique characteristics, they all share some common elements:

Advantages and disadvantages of Share ESOPs:

Let's now explore the advantages and disadvantages of Share ESOPs, shedding some light on their quirks along the way:

Advantages:

Disadvantages:

Advantages and disadvantages of Option ESOPs:

Now, let's turn our attention to Option ESOPs and explore their pros and cons:

Advantages:

Disadvantages:

Advantages and disadvantages of Phantom Shares ESOPs:

Phantom share ESOPs, which provide employees with virtual or "phantom" shares, have their own set of advantages and disadvantages. Let's explore them:

Advantages:

Disadvantages:

Are there differences regarding taxation between the three kinds of ESOP?

Indeed, taxation varies between different ESOPs, and it's essential to consult local tax experts or advisors to understand the specific implications in each country. Taxation on Share ESOPs typically occurs at the time of purchase or sale of shares, considering factors such as the discount received, or capital gains earned. Option ESOPs, on the other hand, may involve taxation upon exercise of the options or the subsequent sale of the shares acquired. Phantom shares ESOPs are basically cash incentives tied to the company performance and are typically taxed as cash bonuses when granted.

Parting Thoughts:

Employee Stock Ownership Plans (ESOPs) come in different shapes and sizes, each offering unique benefits and challenges. Whether it's the straightforward ownership of Share ESOPs or the potential for big wins through Option or Phantom Shares ESOPs, employee ownership creates a sense of pride, loyalty, and dedication among employees. While ESOPs provide exciting opportunities, it's important to weigh the advantages against the potential disadvantages and understand the tax implications specific to each country's regulations.

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