Employee Stock Ownership Plans

1. Determine the company’s value. The IRS and the U.S. Department of Labor (DOL) have issued guidance that the ESOP must pay fair market value for the stock it purchases.

2. Conduct a feasibility study to analyze the overall framework for the transaction and to determine:

• How much the company can afford to contribute to the ESOP each year
• Whether part of the contribution cost can be offset by eliminating other benefit programs
• How the ESOP will affect the company’s earnings and cash flow
• How the transaction will be structured
• How the ESOP will be financed 

3. Obtain financing to purchase stock if a leveraged ESOP is established.

4. Document the transaction with experienced ESOP counsel to prepare all ESOP plan documents once financing has been arranged.

5. Negotiate a stock purchase agreement between the ESOP fiduciary and the selling shareholders, setting the price and terms/conditions under which the ESOP will purchase stock from the selling shareholders. 

6. Obtain a written opinion from an independent appraiser, which is required under DOL regulations, to provide the necessary assurance that the ESOP is not paying more than fair market value for the company stock it purchases. Once an owner decides to proceed with an ESOP, the transaction can typically be closed within three months.

Each year, the company’s cash and stock contributions to the ESOP are allocated to the accounts of participating employees in the ESOP trust. The accumulated balance in a participant’s account is then distributed to the participant after they retire or end employment with the company.

A participant’s account in the ESOP trust, including any appreciated stock value, is not taxable to the participant until the participant takes distributions. Employees age 55 or older with 10 or more years of participation in the ESOP are allowed to diversify a portion of their ESOP accounts.

An ESOP is leveraged if it borrows money to purchase shares of the company’s stock. The loan may be from a financial institution, or the selling shareholder may finance the transaction by taking back a note for part or all the purchase price. The sponsoring company usually uses its assets to secure the financing.