In its simplest terms, an employee stock ownership plan (ESOP), is a qualified defined-contribution benefit plan comprised of company stock, held by shareholders at a company (which is usually all vested employees). An ESOP is a way to sell your company to your employees, enabling all employees to become shareholders in the company, and selling shareholders to obtain liquidity.
ESOPs are a great way to align the financial incentives and rewards of employees with those of ownership, as all employees will own shares in the company. Technically, ESOPs are a standalone entity (a trust), and the ESOP buys some or all of your company and then issues shares to employees.
ESOPs work like this:
- A company decides to sell some or all of its stock to an ESOP.
- A valuation and formal sale process are undertaken, where the business is valued, and a negotiation held between selling shareholders and employees. Employees are represented by a trustee (a lawyer), who advocates on their behalf for the purposes of the transaction, valuation, deal terms, etc.
- Once terms are agreed to between selling shareholders and the third party trustee, a transaction is completed.
- Sell shareholders receive liquidity for their shares, and employees become shareholders.
- The business moves forward in this new operating state, with employees now having equity in the company, and ownership having obtained liquidity (and in some cases, exited all together).
There are many nuances to an ESOP. For example, a company may choose to sell some or all of its stock to an ESOP. Some owners may choose to exit, where others may choose to stay on.
The point is that ESOPs are a highly customizable solution, and through exploration, an ESOP can be designed to meet any number of circumstances.