October 23, 2024
The ESOP vocabulary: Terms for success
A first step to understanding an Employee Stock Ownership Plan is learning some key terminology.
ESOP (Employee Stock Ownership Plan): A qualified retirement plan that allows employees to own shares in the company, often used as a corporate finance strategy and a tool for employee motivation.
Participant: An employee who is eligible to receive benefits from the ESOP and can acquire shares of the company.
Trust: A legal entity that holds the shares of the company on behalf of the employees participating in the ESOP.
Vesting: The process by which employees earn the right to their allocated shares over time, usually based on their years of service.
Allocation: The distribution of shares to individual employee accounts within the ESOP based on a predetermined formula, often tied to salary or years of service.
Distribution: The process by which shares or cash value are given to participants when they retire, leave the company or reach a certain age.
Repurchase obligation: The company’s legal obligation to buy back shares from participants when they leave or retire, ensuring liquidity.
Leverage: Refers to the borrowing of funds by the ESOP to purchase company shares, allowing for immediate ownership while spreading the cost over time.
Fair market value: The price at which shares would trade in an open market, used for determining the value of shares in the ESOP.
Stock valuation: The process of determining the fair market value of the company’s stock, usually performed annually by an independent appraiser.
ESOP loan: A loan taken by the ESOP to buy shares from existing shareholders, which is then repaid using company contributions or cash flow.
Employee buyout: A process where employees acquire a significant or controlling interest in their company, often facilitated by an ESOP.
Source: ESOP Partners, Mainebiz research
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