This is part two of a three-part series introducing different stock plans one should consider for their business. This is only meant to be an introduction; a trusted professional should be contacted to discuss what stock plan is right for your business. This second installment focuses on employee stock ownership plans.
An employee stock ownership plan (“ESOP”) is an employee benefit plan similar, in some ways, to a profit sharing plan. In an ESOP, the employer sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares of its stock. Alternatively, the ESOP can borrow money to buy new or existing shares, with the employer making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, employer contributions to the trust are tax deductible, within certain limits.
Shares are allocated to individual employee accounts. Although there are some exceptions, generally all full-time employees over the age of twenty one (21) participate in the plan. Allocations are made either on the basis of pay or some other formula. Once an employee leaves the employer, assuming they are vested in the stock, the employee receives the stock, which the employer must buy back from the employee at its then fair market value (unless the stock is publically traded). Private companies must have an annual outside valuation to determine the price of their shares, a valuation that can be very costly.
There are drawbacks to the use of an ESOP. Private companies must repurchase shares of departing employees, which can be a major expense. In addition, any time new shares of stock are issued, the stock of existing owners is diluted.