How an ESOP Works – Employee Ownership

An ESOP is a unique tax-qualified employee retirement plan that allows eligible employees to share in the ownership interest of the company where they work. Employees receive the value of their shares earned as a retirement plan distribution when they leave the company or reach specific age and service milestones.

An ESOP is also a flexible, tax-advantaged business transition and corporate finance tool that enables stakeholders in closely held companies to access their equity without giving up management control of the company, which enables an owner to carefully plan leadership succession and a smooth transition.

Our free ESOP readiness assessment makes it easy to find out if an ESOP is right for you.

An ESOP offers a guarantee of fair market value for the shares sold to the ESOP trust

Owners who sell to an ESOP can control their own exit — so they can access the wealth they’ve built without having to depart or cede control to new owners

Selling owners can take advantage of flexibility in terms of structuring the sale transaction to maximize net proceeds over time

A controlled exit enables the seller to carefully plan for succession and leave behind a company that reflects their vision

After selling to the ESOP, many owners can become plan participants and earn shares of company stock over time as employee-owners, as well

Depending on the needs and objectives of the seller, an ESOP sale can offer the possibility of deferring capital gains taxes — in some cases, indefinitely

An ESOP is a type of qualified retirement plan, but it differs from 401(k) or other direct contribution plans. ESOP participants don’t invest their own money. Rather, their shares of company stock are earned over time.

After an ESOP trust is established, the company uses funds that would typically go toward income tax liabilities to pay the selling owner for the shares sold to the ESOP.

Eligible employees earn shares over time, and when they retire or leave the company, they receive their shares as an ESOP distribution, which the ESOP buys back for cash. The company is obligated to pay employees fair market value to repurchase their allocated shares. These payments can be in a lump sum, or in substantially equal payments over up to five years.

In this way, an ESOP provides a retirement benefit to eligible employees — which, in many cases, can include the original selling owner after the ESOP transaction.

By rewarding employees with the opportunity to earn an ownership stake in the business at no cost to the workers, an ESOP aligns the financial objectives of the company with those of employees. In fact, multiple studies have shown that ESOP employee ownership can improve company performance and stability, and increase employees’ job satisfaction.

Offering an added retirement benefit can also help ESOP companies attract and retain high quality employees.

At the same time, the ESOP trust serves an important role in the employee ownership equation. As legal shareholder of stock in the trust, the ESOP trustee takes on responsibility for compliance, legal risk, and the company’s liabilities and obligations to creditors. Employees, as beneficial shareholders, are not accountable for these obligations and responsibilities.

In short, employees get the upside benefits of ownership without the downside risks.

How an Employee Stock Ownership Plan Works

Tax-Qualified, Tax-Advantaged Business Plan

As an Exit Strategy and Business Transition Tool

An ESOP offers a guarantee of fair market value for the shares sold to the ESOP trust

Owners who sell to an ESOP can control their own exit — so they can access the wealth they’ve built without having to depart or cede control to new owners

Selling owners can take advantage of flexibility in terms of structuring the sale transaction to maximize net proceeds over time

A controlled exit enables the seller to carefully plan for succession and leave behind a company that reflects their vision

After selling to the ESOP, many owners can become plan participants and earn shares of company stock over time as employee-owners, as well

Depending on the needs and objectives of the seller, an ESOP sale can offer the possibility of deferring capital gains taxes — in some cases, indefinitely

As a Qualified Retirement Plan

As an Employee Ownership Vehicle

Talk to our experts and see if the benefits of an ESOP are right for you.