When you are a business owner, one benefit you can give your employees is by them owning an ESOP. It will make them feel like they are a part of the company and help to maintain employee loyalty.
What Does ESOP Stand For?
An ESOP is an Employee Stock Ownership Plan. Another name for it is employee share ownership. The employee owns a small part of the company in which they work via stock shares. The value of ESOPs grows through the employee’s tenure so that they can live on its value through retirement from the company.
Publicly traded companies and even small businesses utilize ESOPs, which are in the form of trust funds, to allow workers to have a share of the company. They are funded in one of three ways:
- Companies fund new shares.
- Money is borrowed from the company providing the ESOPs to retrieve the company shares.
- Providing cash assets to purchase company shares that already exist.
The History of ESOPs
In 1974, Congress passed a law that instituted ESOPs. Congress passed the law that was called the Employee Retirement Income Security Act (ERISA). This is the same law that also supervises 401(k) plans for employees.
There are not as many tax benefits of selling a business to a family member or another business colleague versus transferring ownership to employees via ESOPs. Depending on the value of the business, owners should weigh their options on whether they will benefit more financially by selling to new business owners or by transferring ownership via ESOPs.
The Benefits of ESOPs for Employees and Business Owners
Essentially, employees do not have to pay a penny to own ESOPs. The business takes out a loan so that the ESOPs can be provided to the employees based on the overall fair market value of the business.
If a business owner gives employees 100% ownership of the business, the original owner will not have to pay taxes on the profits earned. However, the business owner still runs everything with the assistance of the employees who have a higher stake in the corporate chain of command.
Because of not having to pay taxes on the ESOP profits, you can expand your business with a new building, more employees, and increased marketing to bolster sales. For employees, it’s a retirement plan to help them live after their working years. For business owners, ESOPs give their businesses various tax advantages.
How Do Employees Redeem ESOPs?
Employees have to wait until they are at least 59½ years old to successfully redeem their ESOPs for their retirement. If they were terminated from the company years before they could redeem their ESOPs, then they can be redeemed at age 55.
If ESOPs are cashed out too early, employees may be subject to a 10% early withdrawal fee. Employees should read their ESOP contracts to discover the associated fees with early withdrawal as every stock share company is different.
There are Two Sides to Every Story
While ESOPs might seem like an attractive option, there are always many more factors that play into why they might not be the best decision when an owner is exiting a business. If you’re a business owner and looking for the right exit strategy that makes sense for you, your employees, and the new buyer, then reach out to leading M&A specialists at A. Neumann & Associates who have extensive experience in the business brokerage business and can inform you if an esop is the right option or there is something more attractive.
Conclusion
ESOPs have great tax benefits for business owners while giving employees a stake in the business. They show that employees matter in the scope of business, help to maintain employee loyalty, and have a retirement plan set up for their golden years.
