Employee stock ownership plans (ESOPs) are a qualified retirement plan that allow employees to own shares of the company for which they work. Whether you have just started working for a company that is already owned by an ESOP, or your company recently sold to an ESOP, below are answers to some frequently asked questions about ESOPs.

  1. How does a company come to be owned by an ESOP?

Selling shareholders often choose an ESOP when they don’t want to sell to a third party and risk having the company’s operations relocated, put employees at risk of lay-offs, and want to preserve their company’s legacy.  Many times, these particular founder-owners desire to reward employees who helped build the company and create a new benefit to reward and retain loyal employees.

2.  Is an ESOP like a 401(k)? 

Yes, they are both qualified retirement plans governed by ERISA, but there is a distinction in how each of the plans are funded. Employees fund their 401(k) account and may receive a matching contribution from their employer, but ESOPs are funded with contributions of company stock. In most instances, employees do not purchase shares of an ESOP as they are provided as an incremental employee benefit.

3.  How does stock get allocated to my ESOP account?

Shares are typically allocated to employees based on factors like compensation, tenure, or a combination of both. The specific allocation formula is detailed in the ESOP plan document.

4.  What is vesting and how does it work in an ESOP?

Vesting refers to the percentage of your ESOP account that you have a right to, based on years of service. For instance, a plan might have a 5-year graded vesting schedule where you vest 20% each year. After 5 years, you would be 100% vested.

5.  Who determines what my ESOP shares are worth?

The value of ESOP shares is determined annually by an independent appraiser who considers various financial factors and market conditions related to the company.

6.  How can I track the value of my account over time?

Most ESOP plans have an administrative team that provide employees with annual account balance statements that outline the number of shares each employee holds as well as the current value, which can fluctuate annually.

7.  When can I access or cash out my ESOP shares?

Generally, you can access your shares after a specific vesting period and when you experience a qualifying event, such as retirement, termination, or disability. The distribution rules are detailed in the ESOP plan document.

8.  What if I want to access my ESOP shares before I retire? Can I take a loan against the value in my ESOP account?

Most ESOPs do not allow access before a qualifying event, nor do they permit employees to take loans from the plan. Some 401(k) plans allow for hardship withdrawals or loans, though they often incur penalties and/or interest. Employees should consult the plan documents that govern their ESOP and/or 401(k) plans for specifics on what their companies’ plans allow.

9.  If I own shares of the company through an ESOP, does that mean I have voting rights?

Companies that are owned by an ESOP are governed by a board of directors appointed by the ESOP trustee. Legally, the trustee is the shareholder of record and fiduciary responsible for acting in the best interest of all plan participants.  There are certain instances where the trustee will obtain a vote from plan participants, but generally speaking, employee owners do not have voting rights since the trustee is the legal shareholder of the ESOP trust.

10.  How can I influence the value of my ESOP shares?

Numerous studies cite that ESOP-owned companies outperform non-ESOP companies, particularly during economic downturns. ESOP companies that foster an “ownership mentality” culture experience performance advantages, meaning that employees think like owners and are empowered in their respective roles to increase productivity, efficiency, and profitability. These efforts translate to growing 8-11% per year faster than expected before becoming ESOP-owned.

If you have any questions about your company’s ESOP, contact your HR department or members of your company’s ESOP committee for more guidance.