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What is an ESOP?

ESOP stands for Employee Stock Ownership Plan. ESOPs, like other employee benefit plans, offer advantages to business owners, companies, and employees alike.

An ESOP is a retirement plan designed to provide employees with an ownership interest in the company by investing primarily in stock of the employer. ESOPs are unlike other retirement plans, which typically diversify their holdings by investing in a variety of assets. The ESOP is funded with tax-deductible contributions by the employer, which can be in the form of company stock, or in cash which is used to purchase company stock. An ESOP operates through a trust, under the direction of a trustee or other named fiduciary.

ESOPs must be specifically designated as an ESOP in the plan document, and must comply with special ESOP requirements of the Internal Revenue Service (IRS).

ESOP benefits for companies

An ESOP is a technique of corporate finance as well as an employee benefit plan. An ESOP can be used to finance ownership transition, raise new equity capital, refinance outstanding debt or acquire productive assets. ESOPs can also be used to increase cash flow by making plan contributions in stock instead of cash. ESOP contributions are fully tax deductible, allowing employers to fund both the principal and the interest payments on an ESOPs debt service with pre-tax dollars.

Dividends on ESOP stock are tax deductible if they are applied to repay principal of the loan made to acquire the company stock on which the dividends were paid. Reducing loan principal with pre-tax contributions and dividends generates significant tax savings, which in turn increases the ESOP company’s cash flow. This favorable tax treatment means that ESOPs are effective vehicles for financing ownership transition.

There is strong statistical evidence that ESOP participation improves employee morale and productivity, and reduces turnover. Surveys conducted by The ESOP Association show that most Association members report improved employee morale and productivity from their ESOPs.

ESOP benefits for stockholders

One of the most popular uses for an ESOP is to provide a ready market for some or all of the shares owned by shareholders in a closely held company. With an ESOP in place, a majority or controlling shareholder has an exit strategy when he or she is ready to retire. Likewise, an ESOP is often an attractive buyer for a minority shareholder in a closely held company. With an ESOP, a majority shareholder has the option of selling only a portion of his or her stock to increase personal liquidity while maintaining control of the company.

ESOP benefits for employees

Each year company contributions to the ESOP, in cash or stock, are allocated to the accounts of participating employees in the trust established as part of the ESOP. The accumulated balance in a participant’s account is distributed to the participant after his or her retirement or other termination of employment with the company. So long as a participant’s account remains in the ESOP trust, the value of the account– including the appreciation in stock value– is not taxable to the employee.

Invest in your employees and your business with an ESOP. Let SES Advisors first-class team of legal, finance, banking and tax specialists establish and manage your company’s ESOP.