Employee Stock Ownership Plans (ESOPs) provide employees with an ownership stake in their company through shares held in trust. There are two distinct financial concepts linked to ESOPs:
- first, company-level ESOP financing, where the company borrows funds to finance the acquisition of shares placed in the ESOP trust
- second, employee-level financing, where individual employees may use their vested ESOP shares as collateral to access loans for personal financial needs.
In this article, we focus on comparing the two main types of ESOP financing at the company level: leveraged ESOPs, where the company acquires shares using borrowed funds, and non-leveraged ESOPs, where the company funds share purchases directly without borrowing.
What is ESOP Financing?
Before diving into the leveraged vs non-leveraged ESOP comparison, let’s clarify what ESOP financing means.
ESOP loan financing refers to a loan structure in which employees pledge their vested ESOP shares to receive loan proceeds from financial institutions. One of the prominent leveraged ESOP advantages is that, unlike liquidating shares, which may incur tax liabilities or loss of future gains, participants can retain ownership while accessing funds needed today. These loan proceeds can be used for major personal goals like:
- Buying a house or vehicle
- Funding medical expenses
- Paying for a child’s university fees
- Home renovations
- Wedding expenses
- Holiday funds
By using a portion of ESOP equity as collateral, employees unlock liquidity needed for major life priorities without tapping into the shares’ future upside potential.
Who Offers ESOP Stock-Secured Financing?
Many financial institutions offer loans secured by ESOP equity, with interest rates competitive compared to standard lending products. Terms usually range from a few months to a few years. Companies may also work directly with an ESOP lender to offer financing packages as an extra benefit to employees.
Compared to cashing out stocks, the loan approach keeps more shares in the ESOP longer, which supports employees’ long-term retirement readiness. Employees benefit from addressing immediate expenditure requirements during the process.
Types of ESOP Funding: Leveraged vs Non-Leveraged ESOP
When setting up an ESOP, companies have two main options for financing it: leveraged or non-leveraged. The financing structure has major impacts on how the ESOP functions and offers advantages and disadvantages for the company and employees. Here’s an ESOP financing comparison table to break this down.
| Feature | Non-Leveraged ESOP | Leveraged ESOP |
| Funding Source | Internal (cash or stock) | External borrowing via financial institutions |
| Company Debt | No | Yes, direct or guaranteed by the company |
| Share Allocation | Immediate | Gradual, as the loan is repaid |
| Implementation Complexity | Lower | Higher (due to legal and financial structuring) |
| Best For | Small to mid-size contributions, stable companies | Large share acquisitions, succession planning |
| Cash Flow Impact | Variable and flexible | Predictable contributions, but higher obligations |
| Tax Treatment | Standard deduction on contributions | Often more favourable (depending on jurisdiction) |
| Risk Profile | Low | Moderate to high (due to debt) |
Requirements and Risk Considerations
To qualify for ESOP loan financing, employees typically need a specific number of vested shares in their accounts. A vested share means full ownership - shares that are still vesting usually can’t back a loan. The loan amount may range from 50-100% of vested share value.
Before pledging shares, employees should carefully weigh the risks, just as with any collateralised financing. Share prices and account balances can fluctuate over the loan term. If the share value declines enough, extra collateral may be required. Defaulting could result in the liquidation of shares to repay the loan.
In Summary
While riskier than non-borrowing options, leveraging ESOP equity offers unique advantages. If managed prudently, employees can tap into their ownership stake to access funds for major expenses while avoiding taxes and preserving their nest egg's continued growth. Obtaining personalised guidance to understand the key differences between leveraged and non-leveraged ESOPs is essential in deciding whether borrowing against ESOP shares aligns with one’s circumstances.
