An employee stock ownership plan creates a well-defined structure in which your employees gain stock ownership. It also helps you with your financial goals, including a better alignment between your and your staff's financial goals.
Establishing an ESOP
When you set up an ESOP, you establish a trust to act as a separate legal entity to hold shares of company stock. You directly deposit money into the trust, take out a loan to fund it, or use a
combination of profit and borrowed money. The trust then purchases a predetermined number of shares directly from the company or buys them back from
outside or public buyers.
Once the trust has purchased company shares, it distributes them to employees based on pay grade, length of employment or another equitable formula. Employees generally receive more stock shares as time goes on, much as they do with a regular retirement account that grows with each employer contribution. When the employee leaves or retires, the stock is sold back to the trust. You can then redistribute the shares to other employees or use them as part of your recruitment strategy. Either way, you keep ownership within a core group of employees.
An ESOP also allows you to redistribute the voting shares that control your business; in this way, you can decide whether and when you want to put certain types of the company's voting shares into employees' hands.
Benefits to the company
An ESOP may be beneficial to your company in the following ways:
- Preservation. An ESOP helps ensure your business will continue even after company leadership retires. Further, because employees have a stake in the company's well-being, they're more likely to act for its benefit.
- Low turnover. Employees and management have a strong reason to stay as the value of their shares increases. This saves you money on recruiting, hiring and training new staff.
- Tax advantage. Stock contributions to an ESOP are tax-deductible; you can use the resulting increase in cash flow for any company purpose, including issuing new stock. Cash contributions to an ESOP trust can be deducted whether they're used to buy back shares or as cash reserves for future needs. Dividends and loan repayments are tax-deductible too.
Benefits to employees
Employees similarly reap rewards from a company ESOP:
- Financial planning. An ESOP is a qualified plan, meaning it meets the IRS standards for special tax exemptions and benefits. But unlike with 401(k) plans, employees don't invest their own money. The company invests for them in employer securities.
- Tax-deferred investing. An ESOP grows tax-free until the shares are bought back at retirement, death or separation from the company. At that time, the participant will be taxed at ordinary income tax rates.
- Ownership stake. An ESOP gives employees beneficial ownership — a share in the company's growth in value over time.
The IRS has rules about contribution limits, vesting requirements and administration. Familiarize yourself with these requirements to limit your liability and make sure the tax information you receive is legally up to date. Consulting with your financial advisers will ensure you remain compliant and receive ongoing support for the plan.