There are two ways to think of the employees’ ownership in the stocks of the firm. One is ESOP and the other is LESOP [Leveraged Employee Stock Ownership Plan].The concept of employees owning stock in their employer corporation has its basis in the economic theory of the production of wealth.
In a capitalistic economy, the primary elements for the production of wealth are land, labor and capital as we all know . As the economy has become more technological, labor and capital have become the variable elements in the equation, with capital the more important of the two. Thus, those who control capital, potentially, at least, control wealth. In addition to this emphasis on capital as the main element for the production of wealth, the concentration of wealth through capital formation has been accelerated through the use of corporations.
WHAT IS LESOP[Leveraged Employee Stock Ownership Plan]?
Typically, the ESOP is used as a financing vehicle for the employer corporation. The plan borrows money from the employer or uses the employer’s credit, and purchases employer stock. The borrowed money is paid to the employer for its stock. The loan is repaid with annual employer contributions.
HOW DOES THAT WORK?
A leveraged employee stock ownership plan (LESOP) uses borrowed money to fund an ESOP as a form of equity compensation for employees of their own firm . The company borrows against its assets and then repays the loan used to fund the ESOP via annual contributions to it.The benefit of a LESOP is that a company does not need to expend cash up-front to fund the ESOP.
However, since it involves taking on a large amount of debt, it must be executed with caution. Because it can end up creating problems for companies that can even cause many lawsuits, Employees trust is also at stake.
TAX IMPLICATIONS ON LESOP
Well another aspect is also that of tax advantage. As we have discussed, LESOPs serve as a tax-advantaged method of financing corporate growth because shares allocated to an employee’s account are not taxed until distributions are received and In normal cases, an employee ends their tenure with a company and decides to leave the company.
CONS OF LESOP.
Despite the fact that these plans are the tax-deferred benefit participating LESOP employees enjoy, this plan isn’t without potential downsides of its own and as all investment plans this also inherit an investment risk.
Since we know that LESOP functions as a substitution for other types of qualified retirement plans which are present, they may lack the diversification of a typical retirement portfolio, such as a 401(k) plan, and be too concentrated in company stock. Employees who reach the age of 55, and have completed at least ten years of participation in a LESOP, are permitted to diversify 50% of their accounts, over five years, in investments other than their own company’s stock.
Additionally, since a LESOP involves borrowing factors. And it can make a young company’s debt-to-income (DTI) or debt-to-equity (D/E) ratio, making it appear as a less attractive investment than it may otherwise appear to be. Moreover, if a company cannot repay its LESOP debts, the lender can seize the assets put up as collateral for the payment of such debts.
Thus this can be quite risky for the company but if you have perfect separate staff and people handling these things like hiring a third party to do that job for you and handle these complicated matters for your company.
The ideal candidate for a LESOP is a profitable, closely held cor- operation with a small number of shareholders, little debt, substantial assets, and non-union employees. The LESOP allows the corporation to use its own securities to defer taxes, thereby increasing the amount of capital available “for expansion of the business. By shifting some of the fruits of the production of wealth derived from capital back to labor, it can be used as an incentive for employees to take a greater interest in the employer’s success and the benefits therefrom. It can also be used as a device to transfer control of a business and is, perhaps, the most practical means of keeping a family business in the family. In sum, the LESOP can perform desirable socio-economic functions by giving the independent business person and his employees the means to maintain their positions in the business community.
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