An employee stock ownership plan (ESOP) allows the firm to be sold directly to its employees over a period of time. ESOPs use company stock as a type of retirement benefit for firm employees. ESOPs are perhaps the most common method of transferring company stock to employees. Others include stock options, stock purchase plans and performance based stock bonuses (Payne, 2001).
The typical setup of a leveraged ESOP follows, as explained by J. William Petty (2002). A typical ESOP arrangement involves the firm’s establishing a trust administered by a fiduciary. The firm then guarantees a loan for the trust. The loan is used to purchase the owner’s equity shares, which then becomes the property of the trust and is managed for the benefit of the employees. The firm also makes an annual contribution to the trust in the name of the employees as part of their benefits package. The trust makes payments on the loan using the contributions.
ESOPs provide a steady and tax-advantageous method for the owner to diversify his investment away form the firm. Simultaneously, the ESOP provides a retirement fund for employees and serves to ensure their interest in the continued positive performance of the venture, while the founder shifts operational control. The greatest disadvantages of an ESOP are the requirement for an annual valuation of the firm, the need to appoint a disinterested administrator for the trust, lawyer fees to set up the trust, and a minimum valuation requirement of $2 million (McGee, 2003).