Employee stock ownership plan (ESOP)
An employee stock ownership plan (ESOP) is a federally regulated retirement plan in which a trustee holds company shares in trust. Employees are allocated interest in the shares over time. Estate planning practitioners describe the structure as one that needs a tax-qualified plan and trust plus corporate stock. A leveraged version has the trust borrow money to buy company stock.
How it works
An ESOP centers on a trust. The trust holds the shares on behalf of participating employees.
Many ESOPs are financed with borrowed money. Practitioners point to companies setting up an Employee Stock Ownership Trust that borrows to buy company stock, and call this a very common method known as a leveraged ESOP.
A typical leveraged sale has company debt financing the acquisition of shares. Trust and estate practitioners describe two routes for the purchase. One route is a redemption followed by a sale to the ESOP, and the other is a direct ESOP purchase.
Where it shows up for owners of businesses, real estate and private investments
Owners of operating companies meet the ESOP when a sale of the business to an employee-owned plan is on the table.
Entity type matters as well. The reason given is that an ESOP requires a tax-qualified plan and trust and corporate stock.
Points that are easy to confuse
The plan, the trust and the employees play separate roles in an ESOP. Each role appears in the descriptions of the structure.
- The trustee holds the shares in trust, and employees are allocated an interest in them over time.
- An Employee Stock Ownership Trust that borrows money to buy company stock is the arrangement commentary calls a leveraged ESOP.
- Corporate stock is part of what practitioners describe as the ESOP setup, so the entity holding the business matters.
Common questions
Can a partnership-taxed LLC have an ESOP?
Practitioners note it cannot implement one without adding a corporate entity. The reason given is that an ESOP requires a tax-qualified plan and trust and corporate stock, and a partnership or partnership-taxed LLC does not supply corporate stock by itself.
Is there a limit on the price an ESOP pays for the business?
Practitioners regard fair market value as the ceiling on what an ESOP trustee can pay for the business. The trustee is independent and holds the shares in trust, so the price follows a valuation of the company.