A common question asked within an ESOP is how does my ESOP account grow? There are two common methods through an increase in the number of shares, or by an increase in the value of those shares.
The first way an ESOP account can grow is through the annual release of shares from repayment of the internal loan. Allocations are governed by the plan document, but typically the allocations are completed based on the ratio of individual employee compensation divided by the total eligible compensation of the firm. Assume your compensation was 50K/year and total eligible payroll was 5M/year your allocation would be 1%. So if we assume 10,000 shares are released you would receive 100 shares. If we make a simple assumption that the internal loan has a 10 year term and your percent of the allocation remains at 1% at the end of the 10 years you would have 1,000 shares of stock.
2. Value of shares:
The value of the stock is based on the annual independent valuation of the company. One measure of company value is dependent on company performance (free cash flow) and the potential growth of the company. This is where being an Employee Owner can have an impact on the value of the company. In simple terms profit is equal to revenue – the cost to produce the revenue. As an employee owner if we can grow sales by providing good quality products and service, and minimize cost by efficiency or reduction of waste then all things being equal the value of the company should increase. Of course this is not a guarantee and company value may increase, be neutral to the prior year, or be negative.
3. Cash Contribution
Eventually the internal loan will be paid off and there will no longer be shares to be allocated or released. When this occurs the company will determine the benefit contribution to the ESOP and this cash will be allocated to the eligible employee owners per the plan document. In our prior example this was the ratio of individual employee compensation divided by the total eligible compensation of the firm. if we assume your compensation was 50K/year and total eligible payroll was 5M/year your allocation would be 1%. With a 500K contribution you would receive a 5K allocation. To continue growth these cash allocations would be invested in an “other investments account” as approved by the Trustee.
The above discussion presents a fairly simplified view of ESOP contributions and the potential growth of account value. Each company’s plan and situation may present a unique set of circumstances to be taken into account. No two companies are alike. In general over time the ESOP accounts should increase in value through the growth in the number of shares allocated to the individual and based on the growth in value of the company.