Introduction to ESOPs: What They Are and How They Work

Employee Stock Ownership Plans (ESOP) are a type of retirement plan that empowers employees to own a piece of the company they are helping to build. Both S-Corps and C-Corps can form ESOPs, though they are more common with S-Corps.  

In an ESOP, employees acquire company stock as part of their retirement package, which is often tied to vesting and rewards longevity with the organization. 

Let’s dive into a primer on ESOPs, how they work, their advantages, and the steps for implementing an ESOP. 

How ESOPs Work

Learning the nuts and bolts of how employees acquire shares in a company, through an ESOP, is one of the first questions leadership teams often ask. 

A trust fund is established at the outset of an ESOP. This fund is comprised of newly issued shares as well as cash to purchase existing shares. Once purchased, these shares go back into the trust. Every year, shares of company stock are allocated to each employee-owner’s individual ESOP retirement plan account. This is how eligible employees receive a share allocation.

When participants leave the company or retire, they can request a distribution from their ESOP account, as long as they have met vesting requirements. ESOP distributions are cash payments based on the current fair market value of the shares in the participant’s account at the time of distribution. 

Read more about how shares are allocated in this article. 

Advantages of ESOPs

According to the Employee Ownership Foundation, there are several key advantages to choosing an ESOP over another type of succession plan, such as liquidating the company or selling it to a third-party buyer. These include: 

• The community keeps the local jobs and economic benefits.
• The employees enjoy greater job security. 
• The seller receives fair market value for the company.
• The customers have stability in how they interact with the company. 
• The overall business has continuity in its operations. 

Studies have also shown that companies that utilize ESOPs are often more productive and enjoy a positive, collective internal culture. As a result, ESOPs are also a great recruiting and retention tool. 

Finally, there are tax benefits to forming an ESOP: 

• Owners: An ESOP provides owners with a way to sell their business stock without incurring capital gains taxes. 
• Companies: In addition, S-Corps that are 100% owned by an ESOP pay no income tax, while C-Corps are able to deduct their ESOP contributions from their income taxes. 
• Employees: Since the ESOP is a retirement account, participants don’t pay taxes on their accounts until the time of distribution or withdrawal.

Exploring ESOP Implementation

If you work at an organization that is considering a transition to employee ownership, or if the company already offers an ESOP and you as a leader would like more information about its administration, Aegis Trust Company has resources to assist you. 

Aegis champions the interests of ESOP participants, ensuring continuous employment security and promoting enduring corporate sustainability. This is accomplished through transaction trustee services as well as ongoing trustee services. 

Aegis is Committed to Your Success

Our exclusive focus on ESOPs means we have a team that’s dedicated solely to the best interests of all your stakeholders. Get in touch with Aegis, today, to learn more!