11 Dec Own Stock in an ESOP? You Could Be Lender!
Employee Stock Ownership Plans are popular at many larger public companies. One reason is because employees will have a stake in their company and want it to succeed. But another reason is that it helps get cheaper loans.
A large company borrowing money directly from a bank can deduct the interest on a loan from its taxes. If it “launders” the loan through an ESOP, then it not only gets to deduct the interest but also the principal payment! If the corporation is in the 34% tax bracket, that’s means a hefty savings that may (if the rates are very low) work out to a free loan. Great for the company, not necessarily so great for the employees.
The simple way to do this is to set up an ESOP and have it borrow money in the market. It would then turn around and buy your company’s stock with that money. The company would then have the loan proceeds, the employees would have stock owned through the ESOP, the bank would have a loan to the ESOP (likely secured by the stock). When the company later makes contributions to the ESOP (as part of the employee’s compensation package), the contributions will be used to repay the ESOP loan. Viola, a loan becomes a deductible employee benefit contribution.
In most cases, employees cannot withdraw their interest in the ESOP until they are at least 55 years old and have been with the company for at least 10-years. So, to the extent that you are being paid with contributions to an ESOP rather than cash in the paycheck, there’s a decent chance you are helping get cheap loans for your employer.
That’s not necessarily bad. Unless your company is running into trouble. If it’s short on cash, then it may not be able to make the contributions the ESOP needs in order to pay the outstanding debt. In all probability the stock in the ESOP is also declining in value which, in due course, will cause the bank to take and sell the stock for what it can get.
For healthy companies with growing stock prices, these issues may be fairly minor. The company can lock up some of its stock in stable hands, encourage employee retention and align employee interests with those of the stockholders, and obtaining the tax and borrowing benefits are just an added bonus. But for companies that are now struggling, it could be a way to (in effect) leave the employees with their benefits paying the company’s debt.
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