Definition of the leveraged employee shareholding plan (LESOP)
A stock-based compensation system in which the sponsoring company typically uses its credit to borrow money, which it then uses to fund the plan, to purchase company shares from the company’s treasury. The shares are used for the shareholding plan, and the company repays the original loan with annual contributions.
Understanding the employee leverage share plan (LESOP)
Typically, companies choose to use stock plans or stock-based compensation systems to link part of their employees’ interests to the company’s share price performance. In this way, participating employees are encouraged to ensure the smooth operation and profitability of the company’s operations. And by taking advantage of the company’s assets to feed a LESOP plan, the company can plan its shareholding plan without immediately setting up all the capital necessary to do so.
LESOPs use the product of bank loans to buy shares in the company from the company or from its existing shareholders, at a sale price established by independent appraisers. The lending bank holds the shares purchased as collateral and generally requires payment guarantees from the company, the remaining shareholders or the selling shareholders.
.LESOPs serve as a tax-efficient method of financing business growth because shares allocated to an employee’s account are not taxed until distributions are received, which usually happens after an employee has terminated his mandate in a company.
Due to the deduction limits imposed by tax laws, employer contributions made to make annual loan payments cannot exceed 25% of the annual compensation of a participating employee. In addition, a company may limit participation in LESOP to employees over the age of 21 who have completed at least one year of service.
Despite the tax-deferred benefits enjoyed by participating LESOP employees, this plan is not without potential drawbacks, the main one of which is an inherent investment risk. Since a LESOP works as a substitute for other types of qualified pension plans, they lack the diversification of a typical retirement portfolio. But employees who reach the age of 55 and who complete ten years of participation in a LESOP are allowed to diversify 50% of their accounts, over five years, into investments other than the shares of their own business.