Employee Stock Ownership Plans

You may be able to find equity financing within your own company if you have employees and you are willing to share some ownership control with them.

An Employee Stock Ownership Plan (ESOP) is a qualified retirement benefit plan in which the major investment is securities of the employer's company. In an ESOP, employees can purchase shares of stock in the company by paying cash or by agreeing to reductions from salary or benefits. The employees become part owners of the business and you have additional funds for other business purposes. In addition, the company contributes to the ESOP by either making an annual cash contribution to the plan for the purchase of company securities or by directly contributing stock to the plan. Either way, the company's contribution results in the cash price of the stock being returned to the company. The company gets a tax deduction for the ESOP contribution while effectively retaining the cash.

Work Smart ESOPs may be of further benefit to your company because giving employees a vested interest in the business may promote productivity and a commitment to the long-term success of the company.

Some ESOPs are also used as leverage for borrowing additional funds for the business. An ESOP can borrow funds from lenders in order to purchase additional securities in the employer's business. Alternatively, the employer can borrow from a lender and re-lend the funds to the ESOP; the ESOP would then purchase company stock with the cash. In both scenarios, the employer ends up with the cash price of the stock. ESOPs are sometimes used in this manner for large stock purchases when funding is necessary to finance mergers, acquisitions, or buy-outs.

Because an ESOP requires that you have employees and because implementing an ESOP can be expensive and time-consuming, this financing tool may not be sensible for many startup and existing small businesses. Moreover, you should be aware that plan participants who terminate employment may demand distribution of stock itself, rather than simply the stock's cash value. A closely held business may not want former employees to own stock in the company or to be able to vote as shareholders. In addition, if the trustees of the ESOP are also the business's owners, they may occasionally face a conflict of interest between their duties to act in the best interests of the ESOP and their duties as directors and/or officers of the company. For example, if a takeover offer was tendered, the ESOP might profit from the takeover, but company management might oppose the possible change.

ESOPs are, however, commonly used by business owners seeking to retire from the business. If your small business has grown to the point where you have a fairly large number of employees, an ESOP can provide an excellent way to, in effect, sell your business to your employees because the ESOP provides a ready-made buyer for your stock.

Because of the complexity involved in establishing and maintaining an ESOP, an attorney and/or accountant should be consulted for more details on an ESOP. General information is available from the ESOP Association.