What is a leveraged ESOP transaction?

An ESOP transaction is leveraged if it borrows money to purchase shares of the employer’s stock.

An ESOP transaction is leveraged if it borrows money to purchase shares of the employer’s stock. The loan transaction may be from a bank or financial institution, or the selling shareholder may finance the ESOP transaction by taking back a note for part or all of the purchase price. The ESOP transaction is usually secured by assets of the sponsor company. In some cases, the selling shareholder may be required to guarantee the loan or provide security for its repayment. An ESOP is the only kind of employee benefit plan that can use the credit of the company and its shareholders to finance the purchase of company stock. For all other qualified employee benefit plans, this would be a prohibited transaction under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

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Most ESOPs used for ownership transition purposes are designed as leveraged ESOP transactions, although non-leveraged ESOPs can also be structured to provide significant tax benefits in connection with corporate acquisitions and divestitures.