An Employee Stock Ownership Plan (ESOP) is a trust established by a business which holds its shares. Over time, stock is distributed to vested employees’ personal ESOP accounts, which function as a type of retirement account. ESOPs can be established by S corporations, C corporations, and LLCs that meet specific criteria.
The ESOP trust is initially funded through a business’s stock or cash or through a bank loan. The funded trust then purchases new company shares from the business.
Business leaders can choose to sell their company either partially or wholly to the ESOP trust. Most businesses see tax advantages when at least 30% of company stock is sold to the ESOP trust. If the ESOP trust purchases all ownership shares, the business is 100% ESOP-owned.
Over time, employees become vested in the ESOP and the trust allocates shares to employees’ retirement accounts. This transforms employees into employee owners without requiring any cash contributions from employees. If employees are vested by the time they leave the company, they can cash out their shares.
Any company which employs a minimum of twenty staff members and is valued above at least two to three million dollars is a candidate to launch an ESOP.
The following infographic from the National Center for Employee Ownership describes the life cycle of an ESOP transaction:
The National Center for Employee Ownership (nceo.org) is a fantastic resource to explore to begin learning about Employee Stock Ownership Plans.
Do you still have unanswered questions about ESOPs? In the next blog post in this series, ESOP myths will be discussed and debunked.
References
Menke & Associates, Inc. (2009). “22 ESOP myths & misconceptions.” https://www.menke.com/archives_articles/22-myths-and-misconceptions-3-31-09.pdf.
National Center for Employee Ownership (2018). “How an Employee Stock Ownership Plan (ESOP) works.” https://www.nceo.org/articles/esop-employee-stock-ownership-plan.
National Center for Employee Ownership (2017). “How an ESOP works.” https://www.esopinfo.org/how-esops-work/