United States: ESOPs: A Powerful Tool For Closely Held Banks

David O'Leary is Senior Counsel in the Chicago office

Norman Antin and Jeffrey Haas are Partners in the Washington D.C. office

An Employee Stock Ownership Plan (ESOP) is a powerful and effective tool that can be used for addressing many different issues facing closely held banks. For shareholders in a closely held bank, an ESOP can be used as a succession planning or liquidity vehicle. For the bank's employees, it can provide enhanced benefits useful in attracting, motivating and retaining employees. For the sponsoring bank or bank holding company, an ESOP can facilitate tax-efficient capital enhancement. Most bank sponsored ESOPs own less than 25 percent of the sponsoring bank's stock. However, a few banks are 100 percent ESOP-owned. An ESOP is not an isolated, stand-alone vehicle. To be successful, it must be integrated into the bank's overall strategic plan.

Succession Planning and Liquidity for Shareholders

ESOPs are especially useful as a tool for shareholder succession planning and liquidity. Shareholders in a closely held bank often:

  • desire to implement a succession plan to pass ownership of the bank on to the next generation
  • need liquidity in their estate plan to facilitate payment of taxes or to provide cash for family members
  • need cash for lifestyle changes
  • are nearing retirement age and wish to sell their interests in the bank
  • want to resolve shareholder disputes

ESOPs are a tax-efficient vehicle and can provide tremendous flexibility to a shareholder wanting to dispose of all or a portion of his or her stock in the bank. Often, the transaction can be structured so that a controlling shareholder is able to retain control of the bank following the sale. Depending on the circumstances, the price paid by an ESOP may exceed what a third-party strategic buyer would pay.

If you are a controlling or substantial shareholder of a bank and are considering selling some or all of your stock, you should consider an ESOP as part of any succession planning or liquidity strategy.

Enhanced Benefits for a Bank's Employees

Banks frequently use ESOPs to provide enhanced benefits for their employees. The ESOP often supplements an existing benefit plan, such as a 401(k) plan. It can be a very effective tool for attracting, retaining and motivating employees. Studies have shown that employees of ESOP-owned companies are more productive than non-ESOP-owned companies because they have ownership stakes in their employers.

An ESOP is a special kind of qualified retirement plan designed to give employees an ownership stake by investing primarily in the stock of the employer. The stock is owned by a trust, which is managed by a trustee. The stock is usually allocated to participants' accounts over time, and participants are entitled to a distribution of their accounts on their retirement, death, disability or other termination of employment. The individual participants do not directly own the shares of stock and do not have access to the company's financial records. Generally, the trustee has the right to vote the shares in its discretion. However, certain corporate transactions – such as mergers, reorganizations and the sale of a significant portion of the company's assets – may require "pass-through" voting, which means the participants must be given the right to instruct the trustee as to shares allocated to their account. The administration of an ESOP is very similar to the administration of other qualified defined contribution plans, such as 401(k) plans.

Enhancement of Bank's Capital

ESOPs are often used by banks to raise additional capital or to restructure existing capital using pre-tax dollars. Under this strategy, the bank makes tax-deductible cash contributions to the ESOP, and the ESOP then uses the cash to purchase shares of stock from the sponsoring bank or holding company. Generally, an ESOP must purchase common stock that has a combination of voting and dividend rights at least equal to the class of the bank or holding company's common stock with the greatest voting power and dividend rights. The ESOP can also purchase preferred stock, but only if the preferred stock is convertible into the bank or holding company's common stock.

Example 1: Assume a bank contributes $10,000 in cash to an ESOP. The contribution is tax-deductible to the bank, providing the bank with a $4,000 tax savings (assuming a 40 percent combined federal and state income tax rate). Further, assume the ESOP uses the cash to purchase newly issued common shares from the bank, thereby increasing the bank's common equity by $10,000. The net after-tax cost to the bank of this $10,000 increase in equity is $6,000.

ESOPs may also provide a tax-efficient strategy for a bank or holding company wanting to redeem some (or all) of its non-convertible preferred stock. Under this strategy, the bank or holding company contributes funds to the ESOP, and the ESOP then uses the funds to purchase newly issued common shares from the bank or holding company. The bank or holding company then uses the funds received for the newly issued stock to redeem the preferred shares.

Example 2: Assume the bank contributes $10,000 in cash to the ESOP. Further, assume that the ESOP uses the $10,000 to purchase newly issued common stock from the bank. The bank then uses the $10,000 received from the ESOP to redeem the preferred stock. As in the above example, the net after-tax cost of the redemption of $10,000 of preferred shares is $6,000.

Tax Benefits

ESOPs are often used for the tax benefits they provide. As the above examples illustrate,ESOP strategies can be very tax efficient. Generally, an ESOP transaction is structured in such a way that the bank makes tax-deductible contributions to the ESOP, and the ESOP uses the contributions to acquire the bank's stock or, if the transaction is leveraged, makes payments of principal and interest on the loan that was used to finance the ESOP's acquisition of stock. This pre-tax aspect of an ESOP transaction is what makes the use of an ESOP highly attractive to banks. A shareholder's sale of stock to a non-ESOP buyer or a bank's stand-alone redemption of its stock does not generate any deductions to the bank and is not tax-efficient.

An additional tax benefit is available if the bank is an "S" corporation that is partly or wholly owned by an ESOP. In these situations, neither the bank nor the ESOP pays any income taxes on the bank's income that is allocated to the ESOP. In fact, if the bank is an "S" corporation which is 100 percent owned by an ESOP, neither the bank nor the ESOP will pay any income taxes. Because a bank that is 100 percent owned by an ESOP pays no income taxes, its cash flow is considerably increased.

There are other tax benefits available to the bank and its shareholders, depending on whether the bank is taxed as a "C" corporation or an "S" corporation. For example, if the bank is a "C" corporation and the ESOP owns 30 percent or more of the bank's stock, a shareholder who sells his stock to an ESOP may be eligible to defer (and possibly eliminate) income taxes on his gain on the sale.

Leveraged or Non-Leveraged

An ESOP can be leveraged or non-leveraged, depending on how the ESOP obtains the funds it uses to acquire the bank or holding company's stock.

A leveraged ESOP uses borrowed funds to purchase stock. The usual steps in a leveraged ESOP transaction are: a) a third-party lender makes a loan to the bank or holding company (often referred to as an "outside" loan); b) the bank or holding company loans the funds to the ESOP (often referred to as an "inside" loan); c) the bank makes annual contributions to the ESOP in an amount necessary for the ESOP to make the annual payments on the "inside" loan; d) the ESOP makes the payment to the bank on the inside loan; and e) the bank makes a payment to the third-party lender on the outside loan. As an alternative to obtaining financing from a third-party lender, the ESOP can acquire the stock of the bank or holding company by having the selling shareholders "seller-finance" the purchase of stock.

A leveraged ESOP is often used to enable the ESOP to acquire a block of stock from a selling shareholder as part of the selling shareholder's succession planning or liquidity strategy.

A non-leveraged ESOP purchases stock using existing plan assets, assets of other qualified plans of the bank – such as 401(k) plans – or bank contributions to the ESOP. It is often used by a bank to supplement its employee benefits program. The non-leveraged ESOP uses its own funds or cash contributions received from the bank to acquire small blocks of the bank or holding company's stock. In a non-leveraged ESOP, no borrowed funds are used.

Is Your Bank a Good ESOP Candidate?

An ESOP can provide substantial benefits to a bank, its owners and its employees. However, not all banks are good candidates for adopting an ESOP. Only banks that are structured as a corporate entity can adopt an ESOP. Banks that are structured as partnerships and limited liability companies are not permitted to sponsor an ESOP, although there are often ways to structure the transaction so that a non-corporate bank can benefit from an ESOP.

Banks that are good ESOP candidates generally have a) solid operating performance, b) stable or predictable cash flow, c) a good senior management team and d) payroll sufficient to support the contributions necessary to fund the repayment of the ESOP loan (if the ESOP is leveraged).

If a bank or selling shareholder is interested in undergoing an ESOP transaction, a feasibility study should be done to confirm that the bank is a good ESOP candidate. Generally, the feasibility study is performed by an outside consultant and includes:

  • a preliminary valuation of the bank to determine the approximate price the ESOP would need to pay to acquire the bank's stock
  • an analysis of the effects of the proposed ESOP on all of the shareholders and the financial statements of the bank
  • an analysis of various ESOP plan designs and financing strategies
  • an analysis of the bank's liquidity to determine the bank's ability to repurchase the stock allocated to the accounts of ESOP participants upon the participants' retirement, death or other termination of employment

Implementing the successful ESOP is a team effort, involving the bank's management and major stockholders as well as the bank's accountants, attorneys, financial advisors and existing (or new) lenders. It may also include various ESOP advisors, such as a valuation firm, special ESOP counsel, trustees and investment bankers.


ESOPs provide a powerful estate planning, financial and employee benefits tool for banks and their shareholders. The flexibility of ESOPs and the ability to use pre-tax dollars to finance ESOP purchases make sales of stock to an ESOP a preferred solution for many planning situations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions