Definition of an ESOP
Technically an ESOP is a tax qualified defined contribution benefit plan. Functionally ESOPs are a very flexible financial and equity incentive instrument that uses corporate tax-deductible or “tax-free” dollars to achieve a variety of individual and corporate objectives, including shareholder liquidity, perpetuation, raising working capital, and charitable giving
An ESOP is unlike any other employee benefit plan in that the ESOP Trust, or ESOT, is designed to hold primarily stock of the sponsoring employer.
In its simplest form a company establishes a trust to which the company contributes stock or cash to purchase stock. The stock is then allocated out to employees’ individual accounts within the trust. When cash is contributed it is used to purchase stock from shareholders and then allocated out to individual employee accounts. In the leverage ESOP the, the ESOT borrows the cash to purchase shares then repays the debt with the contributions contributed by the sponsoring corporation.