Employee Stock Ownership Plans

A company interested in establishing an Employee Stock Ownership Plan (ESOP) has a wide range of options in tailoring a plan that is best suited to its particular needs and goals. A large, publicly traded company, for example, would handle the creation of its ESOP somewhat differently than would a smaller firm. Presented below, therefore, is only a basic guideline summarizing the steps a company might take in designing its ESOP and bringing it into being. Once you have a general picture of the kind of ESOP you want, a qualified consultant will work with you to design the specifics of the ESOP. The actual feasibility of an ESOP needs to be established. Custom-tailored answers to the many questions need to be answered. Who will participate in the plan? How will stock be allocated to participants? What vesting schedule will be adopted and how will distributions of ESOP accounts be handled? How will voting rights be handled? The ESOP Association provides the names of such consultants throughout the country. The consultant will work to integrate the ESOP goals with applicable laws and regulations and will conduct a financial analysis to assure that any financial commitments posed by the ESOP will not exceed the ability to the firm to meet such obligations. He or she may also offer possibilities previously overlooked. The consultant may also arrange to bring in other professionals, such as an appraiser, or a lending institution as appropriate.

In the case of a privately held company, the feasibility and design phase of the process is not usually complete until three additional points have been addressed. First, the firm’s stock must be valued by an independent appraiser before shares are put into the ESOP. Initially, a careful estimate will be prepared for use as a working figure in the feasibility and design process. This initial appraisal will likely take several weeks or longer, since a significant amount of business data must be collected and analyzed. Only when the design process is completed and ready for implementation will a final and formal valuation report be prepared. For more information on valuing ESOP stock, visit the Publications and Productssection for Issue Brief #8 “The Valuation of ESOP Stock,” publications “An Introduction to ESOP Valuations,” “Valuing ESOP Shares,” and the “Report on Valuation Considerations for leveraged ESOPs.”

Second, the ESOP’s effect on existing stockholders should be estimated. Stockholders will want to know how the ESOP will affect the value of their stock and the company’s financial condition. Often an ESOP will cause a dilution of their equity interest in the corporation.