Exit Planning

“An employee stock ownership plan (or ESOP) can be a great tool for business transition, enabling the owner to get a fair price, defer taxation on the gain, preserve his legacy, reward and motivate his employees and retain whatever role he desires after the transaction,” says Corey Rosen, Founder of the National Center for Employee Ownership (NCEO).

For the employees, an ESOP is also a motivational tool because it gives them an ownership stake in the company. They earn shares of the company over time, typically at no cost to them, and those shares become more valuable as the company grows.

Here, Rosen explains how it works: The company sets up an ESOP trust designed to acquire the shares and hold them for the benefit of plan participants; the company then funds the trust by making tax-deductible contributions to purchase shares. The company can simply make cash contributions each year over time, or it can borrow money and reloan it to the ESOP trust.

The trust uses that money to purchase shares from the owner. As the loan is repaid, shares are allocated to accounts for the ESOP participants; the amount allocated is usually based on their relative compensation or a more level formula.