ESOP: Employee Stock Ownership Plan

Financing Through Employee Equity

Chase can help private companies create and manage employee stock ownership plans (ESOPs)—often viewed as an alternative to an initial public offering (IPO) or an outright sale.

An ESOP is an IRS qualifying benefit plan similar to a stock bonus or profit-sharing plan. Section 1042 of the Internal Revenue Code provides an election for shareholders of private companies that enables them to permanently defer capital gains tax payments if stock is sold in an ESOP. A company must be, or convert to, a "C" Corporation status to benefit from Section 1042.

Uses of ESOPs

  • Gain liquidity
  • Diversify assets and/or ownership
  • Execute leveraged buyouts

Advantages of an ESOP

  • Provides a market for closely held stock
  • Serves as an alternative to an IPO or an outright sale
  • Allows selling shareholders to defer capital gains tax indefinitely
  • Creates tax deductions for principal and interest payments for an ESOP loan
  • Enhances employee motivation through stock ownership
  • Allows owner(s) to maintain control of the business after sale to an ESOP
  • Provides tax-free diversification
  • Facilitates management buyouts

Types of ESOPs

  • Leveraged ESOP: A leveraged ESOP is one that borrows money to purchase employer stock. The company is usually required to guarantee the loan.
  • ESOP trust: The ESOP trust purchases employer stock with the loan, either directly from the company or from its shareholders. The company is then able to make fully deductible principal and interest payments to the ESOP trust that repays the loans. As the loan is repaid, the stock held as collateral on the loan is released to individual employee accounts
  • Nonleveraged ESOP: This type of ESOP is one in which annual contributions, up to a maximum of 25 percent of the amount of covered payroll, are made each year to the ESOP in stock and/or cash.

Understanding the ESOP Process

Before the ESOP Transaction

  1. A company borrows from a bank or bond markets.
  2. The ESOP borrows from the company (or from a third party with the company's guarantee).
  3. The ESOP uses proceeds to purchase new shares from the company.

After the ESOP Transaction

  1. The company contributions to the ESOP are used to repay the ESOP loan. No net cash flow occurs between the company and the ESOP. Shares are released into employee accounts as the ESOP loan is repaid.
  2. The company uses proceeds from the ESOP loan to repay debts. For a leveraged ESOP, account distributions to employee beneficiaries are not required until the ESOP loan has repaid in full. Footnote  (Opens Overlay)

To learn more about our ESOPs, please
contact us or call your Commercial Banker.