An Employee Stock Ownership Plan (ESOP) is a retirement plan in which the company contributes its stock to a plan for the benefit of the company’s employees. The company maintains an account for each employee participating in the plan. Under ESOP, shares of the company’s stock are vested over a period on behalf of the employee. Employees are provided with such ownership with no upfront costs. The provided shares are held in a Trust for growth until the employee retires or resigns from the company. The purpose of an ESOP is to enable employees to acquire beneficial ownership in the company without having to invest their own money.
To form an ESOP, a company needs to set up a trust fund for employees containing the company’s stock. Shares of the stock will then be assigned to each employee based on their salaries or some other acceptable method. Normally, ESOP will require employees to work for a certain period such as three or six years before getting the initial distribution. When an employee retires or leaves the company, the company will buy back the employee’s shares at the current stock price.
Leveraged ESOP and non-leveraged ESOP represent two structures of the ESOP transaction. In a leveraged ESOP, a bank lends money to ESOP with company guarantee. ESOP buys stock from the company or from existing shareholders. The company makes annual tax-deductible contributions to ESOP, which in turn pays the bank. Employees receive stock or cash when they retire or leave the company. In a non-leveraged ESOP, the company contributes stock or cash to the ESOP to buy stock. Employees pay nothing. ESOP holds the stock for employees and periodically notifies them how much they own and how much it is worth.
In order to execute ESOP, the company establishes a process to operate the plan. The company must select a trustee to monitor the plan. The trustee can be inside or outside the company and the ESOP committee provides oversights. Additionally, the company should provide information to employees to show the benefits of an ESOP and how it makes them owners of the company.
Shuhan Gu, CPA