Employee Stock Ownership Plans: A Strategic Alternative for Banks

by David Joffe, Bradley

There are approximately 800 banks in the United States that sponsor an employee stock ownership plan (ESOP). Although some banks have ESOPs that own a significant portion of their common stock, most bank ESOPs are small, minority holders. Used in such a manner, ESOPs offer a vehicle to provide liquidity for departing shareholders and promote the growth of the bank without materially affecting the bank’s corporate governance. ESOPs also provide a broad-based and desirable employee benefit on a tax-advantaged basis—both for the bank and its employees.


ESOPs are principally retirement plans designed to qualify for certain tax-favored treatment under the Internal Revenue Code. While ESOPs are similar to other defined contribution plans, such as 401(k) plans, they are designed to be primarily invested in the stock of the employer. ESOPs may be maintained by companies that are taxed as corporations (C or S corporations). ESOPs can acquire shares through employer contributions in the form of stock or cash used to purchase stock, and they can also borrow money to purchase stock. When an employee terminates employment, the company must repurchase the shares of stock held for the employee; the company may purchase such shares directly or the ESOP may use any cash it holds to purchase the shares.

ESOP Tax and Other Benefits

ESOPs can provide significant tax benefits. Like other tax-qualified retirement plans, contributions are deductible, subject to certain limits. For a C or S corporation, the corporation can generally deduct contributions of up to 25 percent of its payroll. For a C corporation, if the ESOP borrows money to purchase stock (a leveraged ESOP), the corporation can generally deduct another 25 percent of payroll to make principal payments on the loan and an unlimited amount to make interest payments; such corporations can also deduct certain dividends. If the bank is an S corporation, the ESOP stock will be held by a tax-exempt trust and, as a result, the earnings attributable to the ESOP’s stock will not be subject to tax. The tax liability of participants is deferred until distributions are taken, just like under any other tax-qualified plan. Banks can also use an ESOP to enhance their common equity by making tax-deductible contributions to an ESOP that are used to purchase the bank’s stock. 

Sponsoring an ESOP

Both publicly traded and privately held banks and bank holding companies can sponsor ESOPs. However, ESOPs can be particularly beneficial for privately held banks because they provide an active market for departing shareholders and liquidity for the stock in the accounts of ESOP participants. ESOPs also provide an employee benefit that can reward employees and encourage retention. Stock ownership can be a powerful incentive to attract, retain, and motivate employees. ESOPs can also contribute towards increased long-term shareholder value by being a stable stockholder.


If your bank is interested in establishing an ESOP, the first step is generally a feasibility study. The study will examine the value of the bank’s stock and include pro forma projections for a purchase transaction and estimated after-tax proceeds for any selling shareholders. Banks that are good candidates for an ESOP are generally those with solid operating performance, stable and predictable cash flow, good senior management, and sufficient payroll to support contributions required to retire any debt incurred in a leveraged transaction. In some cases, with adequate disclosure to the participants of the risks involved with such an investment, existing assets in 401(k) or other profit-sharing plans can be used to pay a portion of the purchase price involved in a stock purchase.

While ESOPs can be very beneficial, they are not for every bank. There are costs to set up and maintain the ESOP. The bank will need to have to have sufficient liquidity to satisfy any projected repurchase obligation. There are also a number of regulatory issues that will need to be considered and fiduciary obligations for the ESOP trustee. However, for the right bank, an ESOP can be a dynamic strategic alternative to provide liquidity, enhance employee benefits, and promote long-term stock growth–all on a tax-favored basis.

David Joffe is a partner in the Nashville office of Bradley. He practices primarily in the areas of employee benefits and executive law. He is the Chairperson of the Employee Benefits and Executive Compensation Group.