How to Establish an ESOP

Setting up an ESOP can be a great idea for your corporation. We'll tell you why an Employee Stock Ownership Plan might be an important step for your business and walk you through the basics of ESOP formation.

There are a lot of reasons why an Employee Stock Ownership Plan (ESOP) makes sense for a corporate business entity.

ESOPs can be used to discourage a corporate takeover, to finance capital requirements, or to facilitate the retirement of an owner or someone with a significant ownership stake in the company. However, the most common reason why corporations offer an ESOP is to reward and motivate their workforce.

There's more than one way to establish an ESOP in an existing corporation. Furthermore, when it actually comes time to form an ESOP, you'll need to employ the services of a qualified consultant. In the meantime, here's a general description of what the process looks like:

  • Define your rationale. As you begin the formation process, you need to understand what you hope your ESOP to accomplish. An ESOP that is designed to finance the purchase of capital can be formed much differently than a simple plan that is designed to be an employee reward.
  • Stock valuation. Before you can assign shares to an employee stock option plan, you'll need to conduct an appraisal of current stock value. This appraisal should be conducted by an independent appraiser and should result in a formal valuation report.
  • Consider vesting. Vesting is the method by which employees receive ownership shares in the company. This occurs over time and can be structured in a variety of ways. Almost all ESOPs fully vest employees within 5 to 7 years.
  • Estimate impact on current shareholders. The formation of an ESOP will have a noticeable impact on current shareholders. The stock that is given to employee frequently comes from the value of current stock, resulting in a dilution of existing shareholders equity positions.
  • Plan for buyouts. When an employee exits a company that offer an ESOP, the company may be obligated to repurchase his stock. Although these "repurchase obligations" have the benefit of protecting the company's ownership interests, they can be costly, especially if a large number of vested employees retire or leave at the same time. To accommodate repurchases, make provisions to fund a repurchase account or explore insurance options.

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