ESOPs can offer employees significant retirement benefits and boost productivity, but companies should avoid these potential pitfalls when establishing the program. In the simplest terms, when a company implements a typical ESOP, the existing stockholders sell all or a portion of their shares to the program for allocation to employees. Shares are assigned based on the percentage of total payroll each employee represents.
For example, if a company has $1 million in payroll, someone who made $100,000 would be allocated 10% of the stock. If payroll increased to $2 million, at the same salary, that person’s ownership would drop to 5%. The vesting period ranges from three years to five years, and when employees leave the company or retire, they must sell their shares back to the ESOP for reallocation to remaining and future employees.