An ESOP is also not an Employee Stock Option Plan.
It is a defined contribution retirement plan established under section 401(a) rather than 401(k) and has two major differences. It must invest primarily in stock of the sponsoring company, and can borrow money to do so.
ESOP is an acronym for Employee Stock Ownership Plan.
The name is very misleading since the employees never own any of the company stock.
The plan Trustee owns the stock. The employees only have a beneficial interest in the future profits of the company. They do not own the company and are not involved in its day-to-day operation.
ESOPs are complicated since they must conform to the rules and regulations of both ERISA and Internal Revenue Code as well as to securities law, tax law and corporation law. And they are overseen and regulated by the Department of Labor. Dealing with one Government agency is difficult enough. Dealing with several of them is horrendous.
The rules for Public Companies are different from those of Private Companies.
And the rules for C Corporations are different from S Corporations.
And the rules change when an ESOP borrows money from a bank, the company or a stockholder.
It’s no wonder there is so much misunderstanding and misconceptions about ESOPS.
Information about ESOPs is not taught in Law School or in accounting courses. Most business owners and their advisors have heard about ESOPs, but most of what they have heard is incorrect. A Google search will turn up millions of pages of results. But half of the information is outdated, half is misleading, half refers to ESOPs in other countries and half is just plain wrong. You get the idea!
An ESOP is not feasible unless a company has more than a dozen full time employees since the benefits must be for all the employees, not just a few owners. And since the benefits come from tax savings an ESOP is usually not practical unless the company is paying more than $200,000 in income taxes. Most ESOPs have been established as an exit strategy for the owner. But an ESOP can also be an entrance or doorway to growth strategies for an owner who is interested in growing rather than going.
Yes, an ESOP can increase a company’s bottom line cash flow by 66%, can purchase capital equipment and deduct the cost twice, can repay loans by deducting both interest and principal payments, and can acquire another company using tax free dollars. And best of all, an ESOP can transform your company into a tax free entity forever.
Or maybe the best news is that it can cost nothing to implement an ESOP. Uncle Sam will pay all the costs through tax savings. The net cost to the company and owners can be ZERO.
About the Author:
Harold Lubbock has had an exciting 65 year career in Financial Planning and Consultation from coast to coast across Canada and the United States, and around the world. He’s been an actuary, insurance salesman, investment dealer, financial consultant, estate planner, real estate broker and business broker over the years. President of two public companies, and the CFO of a third and a founding shareholder of two banks, and three Life Insurance Companies, and Managing Director of a Merchant Bank. Involved in the valuation, purchase and sale of hundreds of businesses, ranging from small proprietorships to multi-million dollar public companies, he’s now semi-retired and living in Arizona.