- An ESOP is a highly tax-favored way for employees to share ownership in their company through a trust fund.
- Companies make tax-deductible contributions to the ESOP, and those contributions are either allocated to participant accounts or used to repay the ESOP loan.
- When a portion of the loan is paid, a portion of the shares is allocated to participant accounts.
- ESOPs allocate shares to each eligible employee every year, giving employees and increasing ownership stake as they accumulate seniority.
- The ESOP distributes these shares to employees, usually sometime after they leave the company, so they can use them to fund their retirement.
- All ESOP rules balance two competing interests: that they are flexible enough so the employers will be willing to set them up, but not so flexible that they are easy to abuse.
- An ESOP company is worth what a willing buyer would pay for the company to have the right to its future earnings and current assets.
An ESOP (Employee Stock Ownership Plan) is an employee benefit plan that invests primarily in employer stock.
Advantages of ESOPs:
- Tax-advantaged (to seller, company, employee)
- Company makes tax-deductible contributions of stock or cash to buy stock.
- Stock is allocated to accounts for individual participants.
- Participants receive stock or its cash value on retirement or termination of employment.
- Employees vote stock through a trust.
6 Reasons to Consider an ESOP
- Workers can control the future of their jobs.
- The selling owners can get a fair price for their stock.
- The company can write off the expense of buying the seller’s stock.
- A Sub-S company’s ESOP pays no federal income tax.
- The seller’s proceeds from an ESOP stock sale may be tax-free.
- Sale to an ESOP can preserve the company’s independence and reward the people who made it a success.
Click here for more detail on these reasons.
Best Uses of ESOPs
- Sale of a family owned business (See: Carris Reels, Rosauers Supermarkets, National Forge)
- Sale of a majority interest in a company business (See: Carris Reels, Rosauers Supermarkets, MBC Ventures, Republic Container, National Forge)
- Where payroll is a high % of operating expenses (See: Homeland Grocery, Rosauers Supermarkets)
- Where broad based employee ownership is desired (See: Republic Container, Carris Reels, Rosauers Supermarkets, MBC Ventures)
- When company and sellers have use for tax deductions (See: Carris Reels, Rosauers Supermarkets, Fulton Tool & Die, National Forge)
- Where independent valuation is acceptable to sellers
Most Common Uses for ESOPs
- Cheap capital for business investment, expansion, or divestiture (See: Homeland Grocery, Carris Reels, MBC Ventures)
- Principal and interest tax-deductible (See: Homeland Grocery, MBC Ventures, Republic Container)
- Deduction for dividends to employees
- Deduction for dividends used by ESOP for debt retirement (See: Homeland Grocery, Rosauers Supermarkets, MBC Ventures, National Forge)
- Deduction for dividends reinvested by employees
- Creating a local market for selling stockholders
- Anchoring jobs and local business in local communities (See: Homeland Grocery, Rosauers Supermarkets, Carris Reels, MBC Ventures, Republic Container)
- Local control over future investment and disinvestments (See: Homeland Grocery, Rosauers Supermarkets, Carris Reels, MBC Ventures, Republic Container)
- Basic stock bonus (non-leveraged)
- Leveraged ESOP in C Corp (See: Rosauers Supermarkets, Carris Reels, MBC Ventures, Republic Container)
- Rollover capital gains deferral ESOP (1042) (See: Carris Reels, Fulton Tool & Die)
- Sub S ESOP (See: MBC Ventures, Fulton Tool & Die)