Employee Stock Ownership Plans (ESOPs) are a great way to cash out of your business and essentially turn it into a cooperative in the hands of valued longtime employees.
ESOPs are defined contribution plans governed by the Employee Retirement Income Security Act (ERISA) and operate through a plan trust, according to the National Center for Employee Ownership (NCEO).
“Generally, all full-time employees working for 1,000 hours or more per year become participants in the plans,” NCEO explained on its website. “They receive allocations of stock in their accounts from contributions made by the company and, very rarely, by their own purchases.”
ESOPs are popular because employees are motivated to perform for a company into which they are buying an ownership stake. When the employee leaves the company, the shares are returned to the company for redistribution.
An ESOP generally must include at least all full-time employees meeting certain age and service requirements. Employees do not actually buy shares in an ESOP.
Instead, the company contributes its own shares to the plan, contributes cash to buy its own stock (often from an existing owner), or, most commonly, has the plan borrow money to buy stock, with the company repaying the loan.
All of these uses have significant tax benefits for the company, the employees and the sellers. Allocations must be made on the basis of relative pay or some more equitable formula.
Allocations are subject to vesting, and vested account balances are paid out following retirement, death, disability, termination or a diversification election open to certain plan participants.
Almost all ESOPs are in successful closely held companies and are most commonly used to buy shares from one or more owners using tax-deductible corporate funds.
About 40 percent of all ESOPs own or will own 100 percent of the company. ESOPs range in size from companies with 10 or 20 employees to companies with tens of thousands.
As of 2014, the most recent year for which the NCEO has data, there were 6,717 ESOPs in the United States, holding total assets of more than $1.3 trillion. These plans cover more than 14 million participants, of whom 10.6 million are active participants — those currently employed and covered by an ESOP.