Why Companies Form ESOPs
April 6, 2007

This blog discusses another negative Tribune ESOP article.

Instead of focusing on the negative articles, which are generally written without an understanding of what an ESOP is or how it works, we are going to take some time over the next few days and weeks to talk about the benefits of ESOPs and employee ownership. Today we are going to talk about why companies form ESOPs.

Companies generally form ESOPs (and enter into additional ESOP transactions) for many reasons. Here are some of the more common ones:

• To provide an additional employee benefit (as well as a motivational tool) and to share ownership with the employees of the company. 
• To borrow money to buy the shares of an existing owner(s). If certain requirements are met, the selling shareholder(s) can defer (or even avoid) paying taxes on the gain.
• To borrow money to acquire additional capital, which could be used for many purposes, such as refinancing existing debt, reinvesting in the company, or acquiring another company.
• To utilize the tax advantages of ESOPs. The company can deduct the fair market value of the shares contributed to the ESOP and can make tax-deductible contributions and dividends to the ESOP to fund loan payments. For S Corporations, the portion of income attributable to the ESOP is not subject to federal income tax (and in many cases state income tax).