How to Set Up an ESOP

An ESOP provides tax incentives for employees and for the business.

An employee stock ownership plan (ESOP) is a contribution plan designed to allow participants to invest in the stock of the sponsoring employer. The sponsoring company establishes the plan allowing employees to purchase stock directly. This typically drives employees to perform better on the job since the stock depends on the health of the company, giving employees a vested interest. The plan also provides the organization and its employees several tax benefits such as tax deferment on funds deposited, according to esopassociation.org.

Instructions

1. Conduct a financial study of the company. Some people choose to hire a consultant, however anyone with the time and dedication can conduct the study, according to Robert Frisch, author of" ESOP." Include detailed financial projections for the company and market surveys gleaned from your company's financial records. Determine how much money the company has to devote to the ESOP. Make sure the company has enough payroll to deduct the contributions.

2. Perform a valuation. Knowing the value of stock proves a critical step when starting an ESOP, according to Esopassociation.org. Consider all factors when calculating value. Some of the factors to consider include: cash flow, market conditions and overall economic factors. According to Esopassociation.org, an appraiser prepares a formal and finished evaluation report based on data ideally no more than 60 days older than the date the ESOP is created.

3. Employ an ESOP attorney. Carefully review all options before having the paperwork drafted and sent to the IRS. Discuss with the attorney how you want the plan set up and allow the lawyer to draft the plan.

4. Send the ESOP paperwork to the IRS, or have the attorney mail it. Sometimes, the IRS takes months to reply with a "letter of determination".

5. Obtain funding for the ESOP. Some companies choose to borrow the money from a bank; most banks give ESOP loans. Sellers and private parties can also supply the funding and some insurance companies provide loans for ESOPs.

6. Start making contributions. Even if a letter of determination has not been received from the IRS, the company can still begin making contributions, according to Esopassociation.org. Rarely does the IRS deny an ESOP, and even then, just making amendments to the original plan will set up your final plan.

7. Create a managing process for the ESOP. Set-up a management plan that ensures employee participation so employees stay informed advises Andrew Pendleton, author of "Employee Ownership, Participation and Governance." Establish a committee to direct the overall operations of the ESOP. Appoint a trustee to manage the plan's daily operations.

References

• "ESOP"; Robert A. Frisch; 2010
• "Employee Ownership, Participation and Governance"; Andrew Pendleton; 2001
• The ESOP Association; "How to Establish an ESOP; 2009