II. HOW AN ESOP WORKS
A. Typical Situations Where an ESOP May Be Used. There are a variety of circumstances in which an ESOP may be an advantageous employee retirement plan and a useful corporate finance technique. The following is a list of a few circumstances in which ESOPs have been used:

• Corporations seeking to sell a subsidiary or a division.

• Public company desiring to go private.

• Private company whose principals desire liquidity.

• Founder of business desires to retire and wants to sell business to employees.

• Estate of a deceased shareholder desires to sell stock.

• Collective bargaining over wage or work rule concessions in exchange for stock ownership.

• Defense to a hostile takeover bid.

B. Loan Directly to ESOP The ESOP may borrow directly from a bank, with a guarantee from the sponsoring company. The benefits to the company are the same. This transaction is typically structured as follows:

• The company establishes an ESOP.

• The ESOP enters into a contract to purchase a specified number of shares of employer securities from the existing shareholders or the company for a specified price.

• The ESOP borrows the purchase price of the employer securities from a bank, and signs a non-recourse promissory note to evidence the loan (the "ESOP Note"). As a condition of the ESOP Note, the company gives a written guarantee (and generally other security) to the bank to secure the ESOP's obligation. In addition, the company promises that it will cause the ESOP to repay the ESOP Note and that each year the company will contribute to the ESOP sufficient money to permit the ESOP to make its annual repayment of the ESOP Note to the bank. These arrangements are illustrated in Figure 1.



The ESOP then uses the proceeds of the ESOP to purchase the stock from the existing shareholders or the company as illustrated in Figure 2.



Each year, the company makes a tax deductible contribution to the ESOP, sufficient to enable the ESOP to make its annual debt repayment on the ESOP Note to the bank, as illustrated in Figure 3.