Employee Stock Ownership Plans (ESOPs) were originally created as retirement benefits for employees. In order for ESOP participants to realize the value of the stock, the company will buy back shares that were allocated to the participant accounts.
Based on section 409(h) of the Internal Revenue Code, these repurchase obligations require that privately-held ESOP companies disperse cash payouts to participants based on the distribution and vesting parameters outlined in the ESOP plan document. In the event of a termination of employment, either due to retirement, disability, death or non-retirement termination, the company is still required to repurchase that participant’s shares, also based on the distribution and vesting schedules stipulated in the plan document.
ESOPs require companies to have capital readily available in order to satisfy their repurchase obligations. When they are not accurately accounted for during the initial analysis and design of the ESOP, companies often have to tap into capital reserved for other expenditures, which can constrain growth strategies.
Repurchase obligation study
Companies can conduct a repurchase obligation study to analyze the long-term projection of ESOP distributions and the associated cash requirements likely to arise. This includes assumptions based on a range of demographic and actuarial variables incorporated into a comprehensive financial model that provides an estimation of when the workforce will likely retire. Anticipating when repurchase obligations will likely come due can help the company manage their cash reserves accordingly.
During the transaction process, companies and their advisors should design their plans with sufficient flexibility regarding distribution schedules. While a company may satisfy repurchase obligations with ease when business is good, the company should be equally prepared amidst economic challenges. Writing flexibility into the plan provides the company more control over repurchase obligations during times of distress.