Where’s the Catch?
Because ESOPs were first utilized in larger corporations and are now becoming popular for the small business owner, ESOPs can be expensive to set up and audit. They are regulated by rules from the federal government including reporting, setup, analysis, and/or auditing.
The owners of a company must pay for audits, reports and setup, all of which are tax deductible, however, misuse of funds by the ESOP trustee is sometimes a threat to employee contributors.
Employees should be given ample time and adequate information before buying into an ESOP. If the company needs the money to help it from going out of business, this is not a good idea. If a company with an ESOP goes bankrupt, all the contributions are lost. The upside to this is that the federal government, to ensure the safety of the ESOP, won’t allow business owners to set up an ESOP unless they have been in business for at least three years and have been profitable in each of those three years.
A business owner who establishes an ESOP for their employees may also opt to utilize the employee contributions to expand the business in a loan form without interest. This is legal but the owners of the company must be able to pay back the cash equivalent or stock shares achieved upon retirement.
Expanding the business through an ESOP can also beneficial for the long-term employees who will someday takeover the business through stock share options. Current owners of the ESOP are given tax breaks in ESOP loan expansions and aren’t required to repay any interest into the ESOP plan when repaying the loan.