Employee Stock Ownership Plans


What is an ESOP?

An employee stock ownership plan (ESOP) is an employee benefit plan that invests primarily in the employer’s stock and thus provides the employee-participants with an ownership interest in the company. An ESOP is a tax qualified plan which must satisfy the requirements of the Internal Revenue Code and ERISA (Employee Retirement Income Security Act).

Can an ESOPs Effectiveness be Measured?

There are more than 11,500 ESOP companies covering approximately 10 million employees in the United States. A study conducted by Rutgers University found that ESOPs appear to increase sales, employment and sales per employee by about 2.3% to 2.4% per year versus their non-ESOP counterparts. Another study by the National Center for Employee Ownership shows that ESOP-owned companies outperform their non-ESOP competitors by an average of 28%.

How does a Company establish an ESOP?

To set up an ESOP, a company creates a trust fund for it's employees and funds it with contributions of stock, cash to buy stock, or cash to pay back the ESOP's loan to buy stock. Funds needed to buy the stock are generally supplied by banks, institutions and investors. As a tax driven technique of corporate finance, the ESOP is the only tax qualified and tax-exempt employee benefit plan that can borrow to purchase company stock from the sponsoring company or from its stockholders.

Since ESOPs are creatures of the Internal Revenue Code and ERISA they are highly complex and need to be structured and administered in conformity with the relevant laws. The best ESOP service provider firms will provide comprehensive services, including:

  • Initial consultation, needs analysis
  • Creation of plan and trust documents
  • Submission of appropriate IRS documents, ongoing correspondence with IRS
  • Annual administration/record keeping
    • IRS Form 5500
    • Plan evaluation
    • “Discrimination” Testing
  • Ongoing employee education

What can an ESOP accomplish?

  1. Provide employees with retirement benefits.
  2. An alternative to selling a privately owned company.
  3. Assist in corporate capital formation.
  4. Solve ownership succession issues.
  5. Refinance existing debt.
  6. Assist in estate planning and charitable giving.
  7. Finance acquisitions or divestitures.

What are some of the Advantages?

  1. The stock is sold to the ESOP at current fair market value.
  2. Possible tax deferral on some or all of the profits received from selling the business to the ESOP.
  3. There are strategies that enable some sellers to avoid all taxes on the sale of the business.
  4. Corporate debt can be serviced through tax deductible dividends.
  5. The sale converts the employees into owners.
  6. Company can remain locally owned.
  7. Provides a way for a corporation to spin-off a division or subsidiary to a new company owned by employees in whole or in part through an ESOP.
  8. Enables a company to acquire other companies with tax-deductible dollars.

What are some of the Disadvantages?

  1. An ESOP assisted buyout will usually require the buyers to take on some debt.
  2. The company will have an obligation to provide liquidity to participants at certain ages (for example, to repurchase stock from the accounts of participants who die, retire, become disabled or terminate service).
  3. An ESOP assisted buyout is complex and requires special expertise to structure and administer.
  4. The company could become over-leveraged, thereby inhibiting future growth.

One Source M&A Contact Plan

Please contact us if you would like more information about ESOPs, how they are formed and whether your company would be a viable ESOP candidate. Plexus has developed affiliations with a number of service providers, including ESOP providers. The bottom line is that for many business owners the right ESOP provider can help business owners sell their companies on extremely favorable terms, often tax-free, to their employees. The provider will structure the transactions, arrange the financing, successfully bring it to a close and then subsequently administer the ESOP.