Contact Us (858) 444-2300



1. Will I lose control of my company?

Adoption of an ESOP does not normally result in a change in management. Your company's Board of Directors selects the trustee, who generally retains the right to vote private company shares held in an ESOP.

Plan participants vote the shares allocated to their accounts only on a proposed merger, sale of the business, recapitalization or liquidation.

The trustee you select votes the shares on all routine corporate matters, such as Board of Directors' elections.

2. How do you determine the value of stock held in an ESOP?

The stock's price when purchased by your ESOP trustee, or the tax-deductible amount your corporation claims as an employer in connection with its stock contribution to the ESOP, must not exceed the stock's value, as determined by an independent professional appraiser who must utilize an appropriate appraisal methodology.

Stock is valued at least annually, and participants are informed annually of the value of shares allocated to their accounts.

3. Can I limit plan participation to key executives?

No. As a tax-qualified plan, ESOP participation must be available to a broad cross-section of employees who meet statutory standards, not just to a select group of key executives. However, union employees may be excluded if retirement benefits are the subject of good-faith negotiations with the union.

ESOP benefits cannot unduly favor officers, shareholders, or highly compensated employees--however, you may allocate benefits in proportion to the relative compensation of participating employees, and you may take their years of service into account for vesting of benefits.

4. May an existing pension plan or a profit sharing plan be converted into an ESOP?

Any qualified plan may be converted into or replaced with an ESOP, although different procedures apply to different types of plans.

In the case of converting an existing qualified plan to an ESOP, it is not generally advisable to use the funds of the prior plan to purchase or acquire securities of your company for the ESOP without obtaining the consent of the participants. In some cases, it may be prohibitively expensive to let participants decide whether or not to invest existing funds in securities of your company due to the requirement of complying with federal and state securities laws.

5. What are the typical sources of ESOP financing?

Sources of ESOP financing generally include regional commercial banks, insurance companies, credit and finance companies, and private investors. Your existing lending relationship may also be a potential source for ESOP financing. An experienced ESOP legal advisor has knowledge of ESOP lending sources and can identify and negotiate appropriate loan terms.

Most lenders see the ESOP and the sponsor-corporation as better credit risks because repayment of the loan principal can be made with tax deductible dollars, giving the borrower a significant advantage over most other companies who borrow funds.

6. What limits apply to an ESOP's ability to borrow money to purchase employer securities?

No requirements specifically limit an ESOP's ability to borrow, but practical constraints on the company's ability to make deductible ESOP contributions sufficient to repay ESOP debt control the amount an ESOP may borrow. The law limits annual deductible employer contributions used to repay an ESOP loan to interest on the loan, plus 25 percent of the total compensation of all employees participating in the ESOP.

The Internal Revenue Code also permits ESOPs of C corporations to repay acquisition debt with dividends paid on stock held by the ESOP. Like company ESOP contributions, dividends paid on the ESOP stock are deductible by the company if they are used to repay acquisition debt, but they do not count towards the 25 percent of covered compensation limit described above. C corporations which do not have sufficient covered payroll to repay acquisition indebtedness may use deductible dividends as an additional source of debt repayment funds. Dividends on ESOP stock are also fully deductible if they are paid directly to or passed through the ESOP to the participants.

7. What happens when a participant terminates or retires?

Unless your corporate charter or bylaws restrict stock ownership to employees (a typical provision often added when an ESOP is implemented), a retiring or terminated participant may elect to take his or her benefits in company stock. Otherwise, benefits may be paid in cash.

If company stock is distributed, your company may retain the right of first refusal. Retired or terminated participants who receive company stock from your ESOP have the option to sell those shares back to your company at a fair valuation. The company then has at least five years to pay the purchase price.

8. How are benefits paid?

Distribution of benefits must commence within one year of a participant's normal retirement, disability, or death--or within five years after a separation from service for any other reason.

However, if your company stock was acquired with a loan, you may delay the distribution of benefits to a terminated employee until after the loan is repaid.

9. Can my company be an S corporation?

Yes, beginning in 1998, S corporations have been permitted to maintain ESOPs as a result of the Small Business Job Protection Act. S corporation ESOPs can offer unique and significant planning opportunities in the optimum situation. Special rules apply to S corporations--so careful analysis is needed as to whether an ESOP will meet Internal Revenue Code ownership diversification rules for S corporation ESOPs.

10. How do I get started?

Consult with an experienced ESOP legal advisor. ESOPs must comply with highly technical provisions of tax and employee benefits laws. ESOPs are complicated to design. A legal advisor familiar with such laws can save you time as well as money.


Subscribe to our Newsletter