How do ESOPs share the wealth?

The simple answer is through the annual allocation of ESOP shares and the capital appreciation of the ESOP shares.  For example:

Annual allocation of ESOP shares:

1. ESOPs are based on broad-based ownership.  Every eligible employee in the ESOP shares in the ownership of the company.  It doesn’t matter if you sit in the “C” Suite, or are working on the production floor.
2. Each year the company makes a contribution to the ESOP and the ESOP releases a portion of the ESOP shares held in suspense for the employees.  In most leveraged ESOPs there is a loan between the Company and the ESOP.  Let’s assume there are 500,000 total shares and the loan term is 20 years.  Each year the ESOP would release 1/20th of the shares (25,000 shares) to the eligible employees.
3. The released shares are allocated to the eligible employees per the ESOP Plan.  In most ESOPs this is a ratio based on the employee’s wage compared to the eligible wage base of all eligible employees.  For example let’s assume our typical employee has a total compensation of 50K/year and the total eligible payroll was 3M/year.  The Employee Owner’s allocation would be (50K/3M)*25K shares or ~417 shares!
   1. NOTE – there is no out of pocket cost to the employee – these shares are paid for by the company profits.
   2. Note – to ensure broad based ownership the compensation of highly compensated employees is capped.

Annual allocation of ESOP shares:

1. Each year the company performs an independent valuation to determine the value of the company and what the value of 1 share of the company is worth.
2. The valuation is typically performed using three methods, which include interviewing key company personnel:
   1. Discounted Cash Flow – looking at historical and future predictions of how the company is expected to perform.
   2. Market comparables – how are similar companies valued in the marketplace?
   3. Transaction method – how are similar companies valued in sale transactions?
3. This is where Employee Owners can make a BIG DIFFERENCE  in the value of the company.  Much like sweat equity engaged employee owners can significantly impact the value of the company through reducing waste, being more efficient, sharing ideas on better ways to work.
4. On completion of the valuation – the company will be informed of the value of the company and of the corresponding value of one share of company stock.
5. The Employee Owners gain in the capital appreciation of their shares!

In Summary – Each year the Employee Owner will receive an allocation of company shares.  Each year the company is valued to determine what the share price is and the employee owner will receive the capital appreciation on the held shares.