Employee Stock Ownership Plan Law and Legal Definition

An employee stock ownership (ESOP) plan is a type of defined contribution benefit plan in the U.S. that buys and holds company stock. ESOPs are often used in closely held companies to buy part or all of the shares of existing owners, but they also are used in public companies. Section 401(k) plans are related to ESOPs and may be used alone or in conjunction with ESOPs to hold company stock.

Companies can use ESOPs for a variety of purposes. A small percentage of ESOPs in public companies are used as a takeover defense, for buyouts of failing companies, or exchanges of stock for concessions. ESOPs are most commonly used to provide a market for the shares of departing owners of successful closely held companies, to motivate and reward employees, or to take advantage of incentives to borrow money for acquiring new assets in pretax dollars. In almost every case, ESOPs are a contribution to the employee, not an employee purchase.

The law does not allow ESOPs to be used in partnerships and most professional corporations. ESOPs can be used in S corporations, but special rules and limitations apply. Private companies must repurchase shares of departing employees, and this can become a major expense.