An ESOP can turn your employees
held companies that want investors need look no further than their
own offices. Companies can raise capital through sales of stock
to an employee stock ownership plan (ESOP).
An ESOP is a tax-exempt trust that uses borrowed
money to buy stock in an employer. The ESOP repays the loan out
of dividends and turns the stock over to employees. While the employees
"own" the stock, most ESOPs don't permit workers to sell their shares
until they leave the company.
Of the 15,000 U.S. companies that share ownership
with employees, 10,000 of them do so through ESOPs, and those ESOPs
cover almost 9 million participants, according to Corey Rosen, executive
director of the National
Center for Employee Ownership, based in Oakland, Calif. Most
are privately held and many are small businesses with 100 or fewer
for owners, workers
Both employer and employees benefit from ESOPs. The advantages
- ESOPs provide an outlet for shares in a private
company. It can be difficult for a small business to find buyers
for its shares. ESOPs provide a vehicle, says Andy Patterson,
a manager at the accounting firm of Horty
& Horty P.A., based in Wilmington, Del.
- They permit business owners to raise capital.
An ESOP can borrow money to buy new or existing company shares,
with the company repaying the loan by making contributions to
the ESOP. The loan proceeds can be used to refinance existing
debt, buy out a previous owner, or finance an expansion or other
capital expenditure. In fact, entrepreneurs often use ESOPs to
finance the purchase of a business.
- ESOPs provide a tax benefit. If an ESOP borrows
money to buy stock, the company repays the loan in pretax dollars.
- ESOPs are an employee benefit. Companies
can contribute new shares to an ESOP and take a tax deduction
- Employee ownership of shares can lead to
increased loyalty and decreased turnover. Both are considered
valuable assets in today's low-unemployment economy. In addition,
some experts believe that offering employees a stake in a company
can boost their productivity, provided that the shareholders can
participate in decisions affecting their work, Rosen says.
- ESOPs provide broad-based stock ownership.
Unlike stock options, which are given out on a selective basis,
an ESOP gives all employees a chance to have a stake in the company.
Generally, full-time employees with a year or more of service
at the company are eligible to participate.
Types of employee stock ownership
While employee stock ownership plans (ESOPs) are the most
prevalent, there are other ways to get company stock in the
hand of employees. Here are the various methods and how they
ESOPs: All employees participate. Shares
are allocated to full-time employees with at least a year
of service with the company. Employees receive their share
when they leave the company. At that point, they can sell
them back to the company. Employees own shares through the
trust. Closely held companies can control the voting of the
trustee on almost all issues if they so choose.
Stock options: They allow employees
to purchase shares in their company at a fixed price when
the option is granted for a defined number of years. Option
rights are usually subject to vesting. Not all employees can
or want to participate. They are relatively simple and inexpensive
401(k) plans: Many companies now match
employee contributions to 401(k) plans with company stock.
They also allow employees to choose company stock as an investment
costs can be high
Of course, ESOPs aren't for every company. For one thing, the costs
to set up and administer an ESOP make it prohibitively expensive
for companies with 15 or fewer employees. Corey Rosen estimates
that it costs about $20,000 to set up such a plan. In addition,
the company must be prepared to buy back the stock of employees,
which can be a major expense.
In addition to being expensive to set up and
run, they're also complicated to run, another reason why extremely
small firms should steer clear of them. For example, since their
stocks are not traded on a public exchange such as NASDAQ, privately
held firms must have their companies valued by an independent firm
so a fair stock price can be set. In addition, a trustee must be
appointed to oversee the trust.
Finally, some business owners just don't like
employees as stockholders. "Especially for the business that has
been in the family for 30 or 40 years, there's a perception of a
loss of control, and the business owners don't like that," says
Patterson of Horty & Horty.
A small business owner who is interested in
an ESOP should first explore the feasibility. If the owner decides
to go ahead, the next step should be to hire an outside firm to
conduct a valuation. Provided that the feasibility study and the
valuation give a green light to the ESOP, the owner will next have
to hire an ESOP attorney to prepare and file the necessary documents
with the Internal
In addition, the company will need to obtain
funding for the plan. Potential sources include banks and tapping
the company's existing retirement benefit plan. Finally, the company
will need to set up a process to operate the plan and appoint a
Are ESOPs for every business? Of course not.
But there's a happy ending to an ESOP fable for most privately held
companies that are seeking to enjoin their employees to work as
partners and raise some capital in the process. If it's done for
the right reasons and by a company of sufficient girth, an ESOP
can be a valuable tool.
Jenny C. McCune is a contributing
editor based in Montana
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-- Posted: Feb. 18, 2000