What Is an ESOP and When Is it Valuable for Business Owners?

Employee Stock Ownership Plans (ESOPs) can be a helpful tool for companies and business owners alike. For business owners who want to retire, transition out of their business and/or do succession planning, ESOPs may provide an effective solution.

Not only do these plans give companies the ability to reward their employees, but they also may provide unique benefits and tax advantages and an option for owners to liquidate all or part of their ownership in closely-held companies.

Let’s break down what an ESOP is, how it works and why you might want to consider an ESOP.

What Is an ESOP and How Does it Work?

An ESOP is an employee benefit plan to which employers contribute but employees generally don’t. This 100% employer-funded plan holds shares of the employer in a trust for the benefit of the employees participating in the plan.

The shares of the employer are either contributed by the employer into the trust, are purchased by the trust with cash contributions from the employer or are purchased with loan proceeds.

An ESOP is made available to all eligible employees. This ownership can motivate employees to work toward the company’s success because the stock provides monetary incentives. An ESOP can also help employees feel more valued for the work they do and give them voting rights within the company.

Types of ESOPs: Non-leveraged vs Leveraged

Non-leveraged ESOPs

Non-leveraged ESOPS are funded by cash or existing stock contributions from the sponsoring company or employer. This type of ESOP doesn’t borrow funds or leverage financing in order to buy the stock from the seller.

Leveraged ESOPs

Unlike non-leveraged ESOPs, leveraged ESOPs can borrow or leverage funds to buy stock shares from the selling shareholder. To repay the loan, the employer makes yearly contributions to the ESOP trust. The ESOP uses these funds to pay off the debt.

How Is an ESOP Valuable? What Are the Benefits?

An ESOP’s Value to Employees

ESOPs provide long-term benefits for employees, including:

  • Increased retirement assets: When an employee is at a company for a long time and the stock has appreciated up until their departure, employees can walk away with improved retirement readiness.
  • No-cost benefits: Since employees don’t have to deduct from their payroll or make personal contributions, an ESOP provides them a cost-free retirement asset.
  • Tax advantages: Contributions made or income earned in an employee’s account aren’t taxed until the employee starts receiving distributions. Employees also have the option to defer or decrease taxation with IRA rollovers.
  • Multiple distribution options: Once their employment ends, participants can receive their distributions in cash or stock, per the schedule in their plan’s document. They may also have the option for a single distribution or scheduled distributions.
  • Feeling valued: ESOPs give your employees a sense of ownership and control over their workplace. From voting rights to tax advantages, ESOPs can help create equity, a sense of belonging and a teamwork perspective within your workforce.

An ESOP’s Value to Employers & Business Owners

ESOPs continue to be a popular choice for those who are transitioning out of their business. These plans hold many advantages for employers, such as:

  • Tax and financial benefits: ESOP contributions are tax-deductible, and employers can repay the ESOP’s loan with pre-tax funds. Plus, dividends used to repay the loan may also be tax-deductible.
  • Flexibility: ESOPs provide a wide range of flexibility. They allow for both immediate and gradual ownership transition of a business. They’re also the only benefit plan that can borrow funds to buy employer stock on employer credit.
  • Improved employee performance: Providing employees with ownership participation through an ESOP can make a positive impact. They now have a vested interest in the company’s performance, which can translate to a boost in morale, motivation and productivity.
  • Legacy planning: ESOPs provide a benevolent option for business owners who want to see their employees taken care of after their departure. These plans reward their employees, inspire a sense of community and promote the continuity of the business.
  • Strengthened public image: Establishing ESOPs can shine a positive light on a company’s public image due to its altruistic structure. This can bring favorable attention to a company and be a part of future marketing messages.

An ESOP’s Value to Shareholders

Besides employees and employers, ESOPs host a number of benefits for selling shareholders, including:

  • Creating liquidity: ESOPs in a privately held company create a market for the stocks of outside shareholders. This provides liquidity that wouldn’t otherwise be available, allowing shareholders to receive cash for their shares.
  • Deferred taxation on equity sales: Per the IRS Code, there are tax incentives for particular sales of stock to an ESOP, subject to certain regulations. Proceeds from these sales can be reinvested in qualified securities, which can defer taxes on the sale’s gain.

Making a Business Transition? Learn Whether an ESOP Is Right for You

Wondering if an ESOP is the right direction for your business? We can help. Our experienced certified merger and acquisition advisory professionals provide specialized guidance for every aspect of selling your business.

Learn about our business advisory services and speak to one of our team members by calling us today at 952-844-2500 or send us a message.

“BGM” is the brand name under which BGM CPA, LLC and BGM Group, LLC provide professional services. BGM CPA, LLC and BGM Group, LLC practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. BGM CPA, LLC is a licensed independent CPA firm that provides attest services to its clients, and BGM Group, LLC and its subsidiary entities provide advisory, and business consulting services to their clients. BGM Group, LLC and its subsidiary entities are not licensed CPA firms. The entities falling under the BGM brand are independently owned and are not liable for the services provided by any other entity providing services under the BGM brand. Our use of the terms “our firm” and “we” and “us” and terms of similar import, denote the alternative practice structure conducted by BGM CPA, LLC and BGM Group, LLC.

BGM WEALTH: Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.