How an ESOP Works

For the employees, an ESOP is an employee benefit plan. For the business owner, an ESOP is a tax advantaged way to sell a business.

1. Establish an ESOP trust. The company  sets up an ESOP trust - a legal entity that holds shares of stock on behalf of the employees.  While similar in structure to a 401(k) plan, the trust primarily holds stock in the company.
2. Fund the ESOP trust. The company or the ESOP borrows money (the "ESOP Loan") to facilitate the stock purchase.
3. ESOP trust buys stock. The ESOP trust acquires some or all of the shares from the selling shareholders for Fair Market Value. 
4. ESOP repays loan. The ESOP Trust uses pre-tax contributions or tax-exempt distributions from the company to repay the ESOP loan. 
5. Stock is allocated to employees. The trust allocates shares of stock to individual employee accounts based on a pre-determined formula determined by the company.
6. ESOP trust holds stock for employees. The ESOP Trustee buys, holds and sells the shares of stock for the benefit of the employees.
7. Employees receive retirement benefit. As employees leave the company, they receive their ESOP benefits.