Advantages of an Employee Stock Ownership Plan

Advantages of an Employee Stock Ownership Plan

ESOP Advantages

An Employee Stock Ownership Plan (ESOP) is a tax-qualified retirement plan, where a company sets up a trust fund, into which it sells or contributes shares of its company stock or contributes cash to buy existing shares of stock. ESOPs must have their assets invested primarily in stock issued by the sponsoring employer. Company contributions are typically tax-deductible, within certain limits.

Benefits of an ESOP

ESOPs have a number of significant benefits for selling shareholders, the company and employees, including:

  • Tax deductible contributions: Contributions to an ESOP are tax deductible, generally up to 25% of covered payroll.
  • Portions of ownership are not subject to taxes: In S corporations, the percentage of ownership held by the ESOP is not subject to federal income tax.
  • Opportunities to diversify and defer taxes: Sales to ESOPs allow owners to diversify assets. In C corporations, once the ESOP owns 30% of shares in the company, the seller can reinvest the sale of proceeds in other U.S. securities and defer capital gains taxes.
  • ESOP financing options: An ESOP can borrow money to buy shares and the contributions used to repay the loan are tax-deductible.
  • Increased profitability: Studies have shown that employee ownership increases production and profitability.

Considerations of an ESOP

When considering an Employee Stock Ownership Plan, it is important to know that participant education will be needed to experience the full benefit of the ESOP. Furthermore, there is a cost associated with the annual valuation of privately-held stock.

Additional potential considerations may be:

  • Dilution of outstanding stock
  • Liability for repurchasing shares from participants
  • Possible loss of company control
  • Diversification is required for mature ESOPs

Attributes of an Ideal ESOP Candidate

To better understand the advantages of what an Employee Stock Ownership Plan can do for companies and their employees, it is important to know who makes a suitable candidate to have one.

Typical ESOP candidates are:

  • Owner with a 3-10 year exit strategy horizon
  • Owner with a reasonable valuation expectation
  • Good successor management
  • Stable to growing revenues with good industry conditions and broad client base
  • EBITA in excess of $250,000 and at least 10 employees
  • Controllable cost and expense structures
  • Must be incorporated
  • Good collateral base for bank loan or owner willing to finance the transaction

Talk to your financial professional or tax advisor to determine if an ESOP might be a suitable fit for your situation.

Note: Provided content is for overview and informational purposes only and is not intended as tax, legal, fiduciary, or investment advice.


Note: Provided content is for overview and informational purposes only and is not intended as tax, legal, fiduciary, or investment advice.


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