Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

NCEO employee ownership FAQ hero (keyboard)

What is an ESOP?

An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. It is most often used as a tax-favored way for sellers of closely held companies to transition out of ownership, but it can also just be used as an employee benefit. It is funded out of future tax-deductible dollars, not employee contributions. The hyperlinks in this answer take you to further details or resources on each key point. A good place to start is the ESOP pre-feasibility toolkit.

In an ESOP, a company sets up a trust fund. Most often, the company borrows money and reloans it to the ESOP to buy shares from a seller, but the company can also make contributions of shares to the ESOP or make annual discretionary cash contributions. If the ESOP borrows money, the company makes contributions to the trust to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits. For a detailed look at how ESOPs work see either Selling to an ESOP and Financing the Deal or Understanding ESOPs.

The ESOP can buy any percentage of the company the company decides. Sellers who sell to an ESOP in a C corporation (or an S that converts to C) that owns at least 30% of the shares can defer taxation on the gain by reinvesting in stocks and bonds of U.S. operating companies. In an S corporation ESOP any profits attributable to the ESOP are not taxable. That means that a 30% ESOP is not taxable on 30% of its profits; A 100% ESOP is not taxable on any of its profits.

Shares in the trust are allocated to individual employee accounts. Although there are some exceptions, generally all full-time employees over 21 participate in the plan. Allocations are made either on the basis of relative pay or some more equal formula. As employees accumulate seniority with the company, they acquire an increasing right to the shares in their account, a process known as vesting. Employees must be 100% vested within six years.

In closely held companies, any share purchases or contributions must be based on a fair market valuation by an independent appraiser. The trust is governed by a trustee appointed by the board. The trustee should be an outside professional or firm for any transactions between the seller and the company but can be one or more insiders in ongoing ESOPs. The trustee is appointed by the board and votes the shares in the trust. The trustee does not get involved in the operational management of the firm.

The initial cost of an ESOP is significant, generally (in 2026) $150,000 to $500,000; ongoing costs are a small fraction of that. ESOPs are generally no more complex or costly, however, than sales to another buyer.

When employees leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares). Private companies must have an annual outside valuation to determine the price of their shares. In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights (such as for the board of directors) on other issues. In public companies, employees must be able to vote on all issues.

Link to this FAQ Topic: ESOP Basics & Feasibility