What is an employee stock ownership plan?

An employee stock ownership plan (ESOP) is a defined contribution plan that must have its funds invested primarily in employer securities. The funds, which may come from an exempt loan to the ESOP, are held in trust for, and are used to buy employer securities from stockholders or from the sponsoring company. When a participant retires, dies, or terminates employment, the participant receives his or her benefits in the form of cash or employer securities. A participant generally can demand that he or she receive a distribution of employer securities, unless the employer's corporate charter or bylaws limit the ownership of substantially all employer securities to employees or trusts for tax-qualified plans or impose a right of first refusal. [IRC {SS}409(h)(1), 409(h)(2); Treas Reg {S}54.4975-7(b)(9)]

Another key distinguishing feature of an ESOP is that a participant who receives benefits in the form of employer securities must be given the right to sell (put) the employer securities to the employer for their fair market value within a specified time period after receipt of the distribution if the securities are not readily tradable on an established market. Either the ESOP or the employer may be given the right of first refusal if the participant attempts to sell the securities.