An ESOP, or employee stock ownership plan, allows employees of a specific company to own some part of the stocks of that company. Employees receive tax benefits when they hold a part of their employer's company stock. With an ESOP, employees receive their investment in the company when they retire or find a job somewhere else.
One of the primary disadvantages of an ESOP is that setting up the structure for it in a company is difficult and expensive. To establish an ESOP, you need to have a specific administrator for the program. Since it is a type of retirement plan, this administrator will need to handle annual independent business appraisals. The initial expenses incurred to establish an ESOP are high -- around $50,000 -- and there are also annual costs after the ESOP is already functioning, which can vary from $10,000 to $40,000. You also need a trustee to ensure that the plan works and all parts do not get harmed. It can be very complex to ensure that all the requirements are being met and that the ESOP is working properly.
After a period of five to seven years, if the company does not start to create return for the investments made in setting up a ESOP, it is because the company's performance is poor. In the case that the company is not creating profits, the tax benefits that each ESOP holder was offered are deferred or completely lost. If this happens, employees who were previously motivated strengthen their investment in the company by working harder will now feel that their efforts are useless and that they will not have the same motivations to improve the company's status anymore, making it even less profitable.
When an employee dies or retires, the company must spend money to purchase his stock from him. If an employee leaves the company and does not desire to return his part of the stock, he is not forced to do so. He can still have some voice in company decisions, and he will receive the value of his stock when he retires. If you as the owner of the company do not like this option, this is a clear disadvantage of an ESOP.
The Internal Revenue Service and the Department of Labor have the right to oversee all the plan documents, plan administration, annual valuations, and annual tax filings of the company. That makes it necessary to have an experienced professional administer and establish an ESOP because it will help avoid any complications and a future audit due to any problems that the Department of Labor or IRS might notice.