What is an ESOP?

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What is an ESOP?  An ESOP provides companies with a process to transfer ownership of a company to its employees, while providing methods for the business owner to retain some control and share the value of their business with the people that could benefit most from its success and growth.

Legally, an Employee Stock Ownership Plan (ESOP) is:

  1. A Tax Qualified Defined Contribution Employee Retirement Plan
  2. Qualifies under IRC Section 401(a) & Section 501(a)
  3. Overseen by the I.R.S and the Department of Labor
  4. Formalized in ERISA 1974
  5. Requires the formation of a TRUST, much like your 401k plan
  6. Requires the selection of a Trustee and Directors of the board.
  7. Requires more reporting to the Department of Labor  (DOL)
  8. Has potential Tax Incentives such as 1042 Rollover for C-Corps, principle payment deductions and 100% S-Corp ESOP Tax deferrals.

For business owners, it is one of several techniques that best liquefy their biggest asset for an exit or estate plan and enjoy a tax benefit.

For employees, it is way to benefit from their efforts, and create an opportunity to share in the owner’s value for their own retirement.

For Families of a family business, ESOPs are a great way for purchasing a block of ownership shares with a tax benefit for the sellers, and not lose control over the company. 

For division managers and their employees of large companies that are threatened by corporate change, it is a technique for key managers and their employees to purchase their division from corporate, and provide ownership benefit for all employees.  The same can be said for managers who are worried about their future with owners who are trying to work out their retirement plans.

There are two characteristics which distinguish good ESOP candidates from those who need not apply--profitability and relatively high compensation levels.

The reason is with strong cash flows (EBITDA), the ability to pay off huge debts is strong and will attract outside financing at higher proportions. That being said, there are a number corporate finance benefits that 401k’s don’t offer:

  1. An ESOP can borrow money to purchase a company or some portion of it. Other pension plans cannot borrow funds. ESOPs can also borrow funds for company expansions or capital improvements.
  2. An ESOP invests primarily in employer stock, whereas regular pension plans normally diversify their investments. ESOPs can own anywhere from a fraction of 1% to 100% of a company's stock.
  3. ESOP stock is held outside the company in a separate trust. The trustee acts on behalf of, and in the best interests of, all the employee participants. Within the trust, separate accounts are maintained for the individual stockholders.

Is an ESOP right for you? Take our FREE quiz to see if your company's profile is a great fit for being an ESOP.

Our advisors will be able to guide you through the complexity and develop the best approach towards your journey with ownership transfer.