The Nuts and Bolts of an ESOP

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Updated Jun 6, 2022

While no two ESOPs are alike, the most common themes found around such programs are eligibility and enrollment requirements.

In the aftermarket, most distributors require an employee to work a minimum of 12 months. After that period is completed the employee enters the ESOP at the next available joining date, typically January 1 or July 1.

Once an employee enters an ESOP, stock is commonly awarded as follows:

  • After the conclusion of the year a company undergoes its annual financial audit, during which the company’s financial advisor determines the valuation of the company’s stock.
  • For companies still paying off an ESOP, funds required for the purchase of the business are allocated.
  • Using the company’s valuation and profit figures, corporate leadership works with a trustee to determine how much money will be converted to stock and contributed into the ESOP.
  • Using parameters developed during the creation of the ESOP, a financial advisor determines how much stock each employee will receive. These parameters are regularly built around hours worked during the year and payment compensation levels.
  • The stock ownership adjustments are made to each employee’s account. Employees new to the ESOP are awarded stock for the first time.
  • Balance statements are mailed to each employee noting the stock ownership and valuation changes.

Because ESOPs rely on end-of-year financial data, the calculation and distribution of stock regularly comes six to nine months after the close of the prior year.

Payment for exiting employees can take even longer.

ESOP rules require businesses to repurchase any departing employee’s shares at full market value, but do not require the repurchase and payment for the shares to be made simultaneously or instantaneously. Businesses can dictate when forming an ESOP how employee exits will be paid out—through single payments or over time. The latter can be especially advantageous for small businesses as it minimizes the risk of long-term employee payouts weakening the temporary liquidity of a business.

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