ESOP - Employee Stock Ownership Plan
ESOPs can be accomplished in a variety of ways. Employees can purchase stock directly, can receive stock options, be given it as a bonus, or acquire stock via a profit sharing plan. Some employees develop into owners through worker cooperatives where everyone has an equal vote. The most common form of employee ownership in the U.S. is the ESOP. Essentially unknown until 1974, about 11,500 companies now have these plans, covering over 8.5 million employees.
Businesses can use ESOPs for a variety of purposes. ESOPs in public companies are used as a takeover defense, however, this only explains less than 2% of all ESOPs. Nor are buyouts of fading companies (1% of the plans) or exchanges of stock for concessions (3% of the plans) common purposes. Instead, ESOPs are most frequently used to supply a market for the shares of departing owners of successful closely held companies, to motivate and compensate employees, or to take advantage of incentives to borrow money for acquiring new assets in pretax dollars. In nearly every case, ESOPs are a payment to the employee, not an employee purchase.
An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits.
Shares in the trust are allocated to individual employee accounts. Although there are some exceptions, generally all full-time employees over 21 participate in the plan. Allocations are made either on the basis of relative pay or some more equal formula. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting. Employees must be 100% vested within three to six years, depending on whether vesting is all at once (cliff vesting) or gradual.
When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares). Private companies must have an annual outside valuation to determine the price of their shares. In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights (such as for the board of directors) on other issues. In public companies, employees must be able to vote all issues (National Center for Employee Ownership).
Utilizing Employee Stock Ownership Plans - ESOPs
- To create additional benefit to an employee- ESOPs typically are used in conjunction with employee savings plans. Substituting matching employee savings with cash, corporations match their contributions with stock from the ESOP, which is often given with a higher matching level.
- To buy shares of the departing owner- ESOPs are used to create a market for privately held companies. The company can make tax deductible cash contributions to the ESOP to buy out the owner's shares.
- To borrow money at a lower after-tex cost- ESOPs borrow cash, which then can be used to buy company shares or shares of existing owners. The organization subsequently will then make contributions to the ESOP to repay the loan, which makes both the interest and principal deductible.
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