Employee Stock Ownership Plan ("ESOP")
An ESOP is a qualified plan designed to provide employees with ownership interests in their employer by investing primarily in the employer's stock.
How Does An ESOP Work?
In an ESOP, the company sets up a special trust and then either contributes to that trust cash to buy stock from existing owners or shares of its own stock. Stock held in trust is then allocated to the individual accounts of employee participants. In general, the number of shares each employee receives is based on the ratio of his or her salary to the total amount of salaries of the employees in the ESOP. Employees acquire a gradually increasing right to the stock in their accounts as they accumulate seniority, a process known as "vesting". When employees receive their shares (usually when they leave the company or retire) they can hold onto the shares, sell them to another buyer (but the company has a right of first refusal), or require the company to repurchase them at fair market value.
What Are The Benefits Of An ESOP?
ESOP's have several uses, including:
- Providing an employee benefit plan
- Creating a market for stock in a closely held corporation
- Integrating employees into the company to enhance their commitment
- Allowing the company to repay ESOP debt with pretax dollars
- Allowing individual shareholders to defer gain on the sale of shares to an ESOP
- Enabling the company to borrow money less expensively
ESOP'S As Financial Vehicles
Leveraging an ESOP is a useful corporate financial tool. An ESOP is permitted to borrow money from a lender to purchase stock directly from the company. The shares generally are used as collateral for the loan. The company makes annual, deductible cash contributions to the ESOP trust in amounts sufficient to repay the loan. As the loan is repaid, a proportionate number of the shares are released to participants' accounts. The effect of this is that loan proceeds become available for general corporate use and shares of stock are transferred to the ESOP trust. The company can then use the proceeds to expand, acquire a target company, buy out another owner or refinance existing debt.
Is An ESOP Right For Your Company?
If you are considering an ESOP for your company, you should contact one of our attorneys to discuss whether an ESOP can fulfill your company's objectives.
