What's an ESOP? Employee Stock Ownership Plan Basics and Benefits

An Employee Benefit and Shareholder Liquidity Strategy

An employee stock ownership plan (ESOP) enables privately-held companies to sell equity, at an independent valuation, to an employee trust. These are not stock options plans. Instead, an ESOP is an ERISA-authorized retirement plan that invests directly in employer securities.

Read ahead for details on how ESOPs work, key benefits, and employee ownership pros and cons.

And for a quick study on the basics of leveraged ESOPs, download our concise guide.

Two Common Types of Employee Stock Ownership Plans

Contributory ESOP

A closely-held company establishes a plan and periodically issues new stock to an employee trust. Cash can also be contributed to the trust so that it may buy company shares. The sponsor receives tax deductions equivalent to the fair market value (FMV) of equity at the time of contribution.

How a Leveraged ESOP Works

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Who is the Buyer?

An employee stock ownership trust, representing at least 10 ESOP participants, buys company stock.

Who Sets the Price?

The price is negotiated with an institutional trustee, based on an independent valuation.

How is it Funded?

Sponsors borrow money on the trust's behalf, in the form of third-party financing and/or seller notes.

Who Gets Shares?

Full-time eligible employees are allocated company shares, proportional to their annual compensation.

How is Stock Earned?

A portion of all ESOP shares is allocated annually; the shares vest within three to six years.

How do Employees Cash Out?

Vested stock is sold back to the company, at a current valuation, when employees depart.

Who Benefits from Employee Ownership?

BUSINESS OWNERS

Selling shareholders gain liquidity and asset diversification

Can defer capital gains taxes on sale proceeds

Maintain upside potential and an important role in the company

COMPANIES

Receive tax benefits that enhance corporate cash flow

Employee-owned S corporations can become income tax-free entities

Create a novel employee benefit plan to retain and attract talent

EMPLOYEES

Full-time employees earn ownership interest and gain a unique retirement benefit

Can reap the benefits of company performance

Employee owners secure workplace stability and peace of mind

Employee Ownership Questions? We can Help.