What it means
An ordinary employee stock ownership plan (ESOP) is a trust that holds company shares for the benefit of staff. The trust normally receives shares or cash donated by the company each year.
A leveraged version adds a loan, so that the trust can buy a large block of shares up front rather than building the holding gradually. The mechanics usually work like this.
The trust borrows from a bank or from the company itself and uses the cash to buy shares from the company or from existing owners. The shares are held in a suspense account, and as the company makes contributions that the trust uses to repay the loan, a matching portion of shares is released and allocated to individual employees.
The company often guarantees the loan, and in some jurisdictions the contributions used to repay it can receive favourable tax treatment. In the United States, for example, rules have allowed companies to deduct certain ESOP contributions, which can make the arrangement attractive.
The exact rules differ by country and change over time, so professional advice is needed. LESOPs have several business uses.
A founder who wants to retire can sell the company to the employees through the plan and receive cash at once. A company can also use a LESOP to raise capital, reward staff, or defend itself against an unwanted takeover by placing a large block of shares with friendly holders.
There are risks. The company takes on debt, so cash flow must be strong enough to meet the contributions.
Employees also end up with a concentrated holding in their employer, so if the business struggles, they may lose both their job and a large part of their retirement savings.
In practice
Real-world examples.
Example
The founder of a family-owned engineering firm wants to retire but does not want to sell to a competitor. The firm sets up a LESOP, borrows $6,000,000 and buys the founder's shares. Staff gradually become the owners as the loan is repaid from company contributions.
Example
A mid-sized logistics company wants to reward its drivers and warehouse staff and reduce staff turnover. It creates a LESOP so that employees build ownership over time. After a few years, management notices that retention has improved.
Example
A listed manufacturer faces an unwelcome takeover approach. Its board arranges a LESOP to buy a block of shares, placing them with employees who are likely to support management. The move makes a hostile bid more expensive and more difficult.
Formula
Calculation
Shares released each year = Total shares in suspense account x (Loan principal repaid in the year / Original loan principal)
This uses the principal-only method for simplicity; some plans release shares based on principal and interest combined.
Worked example: a LESOP borrows $2,000,000 to buy 100,000 shares at $20 each. The loan is repaid in equal principal instalments over 10 years, so $200,000 of principal is repaid each year.
Share of loan repaid in a year = $200,000 / $2,000,000 = 10%.
Shares released each year = 100,000 x 10% = 10,000 shares. At a share price of $20, that is $200,000 of stock. If the plan allocates shares by pay and an employee earns 5% of total eligible pay, her allocation for the year is 5% x 10,000 = 500 shares, worth 500 x $20 = $10,000 at that price.Case study
Seen in the real world.
Oakridge Printing is a fictional company with 120 employees. Its founder, aged 66, wanted to sell but feared a buyer would close the plant. Together with the finance director, she designed a LESOP that borrowed $3,000,000 from a bank, guaranteed by the company, to buy 60% of her shares.
The company contributed about $400,000 per year to repay the loan, and shares were released to staff each year. The founder received cash at once, and the staff received a stake that grew as the debt fell.
Three years later, a downturn cut profits and the company struggled to fund the contribution. The board negotiated a longer loan term, and trading recovered. This is an illustrative story, but it shows both the appeal and the cash flow pressure of leveraging an employee plan.
Watch out
Common mistakes.
- Assuming employees pay for the shares. In a typical LESOP the company funds the repayments, and employees receive shares as a benefit rather than buying them.
- Ignoring the debt burden on the company. The loan must be repaid even in a weak year, and the contributions can strain cash flow.
- Overlooking concentration risk. Employees' savings and income both depend on one company, so a downturn hurts twice.
Questions
People also ask.
What does LESOP stand for?
Leveraged employee stock ownership plan. The word leveraged means that debt is used to buy the shares.
How is a LESOP different from a normal ESOP?
A normal plan acquires shares gradually through contributions, while a LESOP borrows to buy a large block at the outset. The loan then drives the timing of share allocations.
Who guarantees the loan?
Often the sponsoring company, and sometimes the original owners. The lender looks to the company's cash flow for repayment, so the guarantee is a real obligation.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%