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ESOP Guidelines

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ESOP Guidelines

ESOP Guidelines were created to streamline the design of employee stock ownership plans (ESOPs). ESOPs provide a company’s workforce with an ownership interest in the company.

ESOP Guidelines for setting up ESOPs

ESOP guidelines start with determining the company’s value, since the ESOP cannot pay more than fair market value for the stock it purchases. Both the IRS and the U.S. Department of Labor (DOL) have issued ESOP guidelines governing the valuation of company stock in ESOP transactions.

The next ESOP guideline is a feasibility study to analyze the overall framework for the ESOP transaction. Among the issues the study should address are: how much the company can afford to contribute to the ESOP each year; whether part of the contribution cost can be offset by eliminating other benefit programs; how the ESOP will affect the company’s earnings and cash flow; how the transaction will be structured; and how it will be financed.
ESOP guidelines for leveraged ESOPs state that a loan must be secured to finance the stock purchase transaction. Financing an ESOP transaction can be difficult if the lender is not familiar with ESOPs. If the seller finances the purchase transaction, the company’s costs will likely be reduced.

ESOP guidelines for plan documents

Legal counsel should prepare the ESOP plan documents. An ESOP sponsor has many choices to make in designing a plan that will work well in its own corporate culture. For that reason, it is advisable to work with experienced ESOP counsel in designing the ESOP.

The next ESOP guideline is to negotiate a stock purchase agreement between the ESOP fiduciary and the selling shareholder(s). The stock purchase agreement sets forth the price and other terms and conditions under which the ESOP will purchase stock from the selling shareholder(s). As in any stock purchase transaction, the stock purchase agreement typically contains representations and warranties about the companys assets, operations and financial condition.

ESOP guidelines for transactions

The final step before closing the ESOP transaction is an opinion from an independent appraiser. This opinion is required under DOL proposed regulations, and provides the necessary assurance that the ESOP is not paying more than fair market value for the company stock it purchases. In some cases the appraiser will also be asked to give an opinion that the transaction as a whole is fair to the ESOP from a financial point of view.

ESOP guidelines for fiduciaries

Any person with discretion over the management or administration of an ESOP plan, or who exercises any authority or control over plans assets, is a fiduciary under ERISA. The ESOP trustee, or any other person or committee designated in the plan documents as responsible for making investments in company stock, is a named fiduciary.
ERISA requires that plan fiduciaries act prudently and solely in the interest of plan participants. Three of the most important responsibilities of an ESOP fiduciary are:

  • Securing a proper valuation of the stock
  • Assuring that the interests of plan participants are protected in ESOP transactions
  • Approving purchases and sales of ESOP stock.

The risks of a fiduciary violation of are reduced if the ESOP engages experienced, competent ESOP advisors, and the ESOP fiduciaries exercise their best independent judgment after reviewing all aspects of the transaction and fully informing themselves of the alternatives.

SES Advisors can help you every step of the way through the ESOP lifecycle, from establishing the initial plan to ESOP record keeping, third party administration (TPA), financial reporting and more.

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