DEFINITION of 'Leveraged Employee Stock Ownership Plan - LESOP'

An equity compensation system in which the sponsoring company typically leverages its credit to borrow money, which it then uses to fund the plan, in order to purchase company shares from the company's treasury. The shares are used for the purposes of the stock ownership plan, and the company pays back the original loan with annual contributions.

BREAKING DOWN 'Leveraged Employee Stock Ownership Plan - LESOP'

Typically, companies choose to use stock ownership plans or equity compensation systems in order to tie a portion of their employees' interests to the bottom-line share price performance of the company's stock.  In this way, participating employees are given incentive to ensure the company's operations run as smoothly and profitably as possible. And by leveraging the company's assets to fuel a LESOP plan, the business is able to provide for its stock ownership plan without immediately putting up all the capital required to do so.

LESOPs use the proceeds of bank loans to purchase company stock from the company or its existing shareholders, at a sale price established by independent appraisers. The lending bank holds the purchased shares as collateral and typically requires payment guarantees from either the company, the remaining shareholders or the selling shareholders.
.LESOPs serve as a tax-advantaged methods of financing corporate growth because shares allocated to an employee's account are not taxed until distributions are received, which generally occurs after an employee ends his or her tenure with a company.

Due to deduction limitations dictated under tax laws, employer contributions made to make annual loan payments may not exceed 25% of a participating employee's annual compensation. Additionally, a company may limit LESOP participation to employees who are over age 21, who have completed at least one year of service.

Potential Downside

Despite the tax-deferred benefit  participating LESOP employees enjoy, this plan isn’t without potential downsides—chief among them: an inherent investment risk. Since a LESOP functions as a substitution for other type of qualified retirement plans, they lack the diversification of a typical retirement portfolio. But employees who reach the age of 55, who complete ten years of participation in a LESOP, are permitted to diversify 50% of their accounts, over a five-year tiem period, in investments other than their own company’s stock.

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