Growing Your Company with ESOPs

The success of a company is closely linked to its ability to grow. In a study conducted by Rutgers University, Douglas Kruse and Joseph Blasi discovered that companies that offerEmployee Stock Ownership Plans (ESOPs) grow at a rate 2.3% to 2.4% faster than companies without ESOPs. Would you like to capitalize on this information? Though you should consult an attorney for advice pertinent to your company’s unique situation, here are some of the most common uses and benefits of ESOPs

 What is an ESOP?

An employee stock ownership plan is a type of employee benefit plan known as a deferred compensation plan. The employer contributes a pre-determined amount of shares to an employee’s account over time, and in the event of the employee’s retirement, death, disability or termination, the employee’s account is distributed to him or his beneficiary. The amount the employee receives will depend upon the value of the stock at the time.

It is important to note that an ESOP is a qualified plan, meaning the ESOP’s managing company and the employee participant can receive specific tax benefits.

What Are the Employee Benefits of an ESOP?

• Provides Tax Benefits

The employee is not taxed on the contents of her ESOP until she receives the benefits, and even after this, income tax consequences can be lessened using averaging methods.

• Rewards Employees who Stay with the Employer

Most companies design ESOPs to reward those employees who stay with them the longest. To obtain vested benefits (nonforfeitable benefits), the employee must usually work a set amount of years. In a popular vesting schedule, the employee’s vested benefits increase after the second year of service, and he obtains 100% vesting after six years. After this point, the employee is entitled to 100% of his ESOP benefits, whether he decides to leave, is fired, etc. If the employee becomes disabled, retires, or dies before becoming 100% vested, he will usually receive the full benefits whether or not they are vested.

What are the Employer Benefits of an ESOP?

• Provides Tax Benefits

Employer contributions to ESOPs are tax-deductible. S-Corporation ESOPs are completely exempt from unrelated business income tax.

• Creates an Additional Stock Market

Shareholders can sell their stock to ESOPs. Those who do so can receive a tax incentive under special conditions, possibly preventing them from paying taxes on the sale profits.

In addition, because of the “ESOP” stock market, the company can avoid going public and all the expenses and headaches associated with doing such.

• Can be Used to Finance Acquisition Purchases

Because ESOPs can borrow funds to purchase company stock, they can be used by employers to achieve a number of objectives, including financing acquisition purchases. For example, the purchasing company can use ESOP contributions to pay off acquisition debts with pre-tax dollars.

• Can Act as an Exit Strategy

A business owner can sell his shares to the ESOP when he desires to leave the company. This exit strategy has several benefits: the owner can sell his shares in the company gradually, creating a smoother transition; he can avoid selling out to other companies or third-parties; and he can receive tax-benefits from the sale.

Growth is never a bad thing when it comes to the success of your business. If you are interested in growing your company at a faster rate, consider the use of ESOPs, as they offer tax benefits, function as financing tools, create an internal stock market, benefit employees, and more. To determine if ESOPs are a good fit for your company, consult an attorney today.