In this way, the cash flow of the corporation is enhanced because a noncash deduction is being taken which lowers corporate income tax and increases net worth. A small business owner may use an ESOP for many different reasons. In its truest planning sense, an ESOP is needed by many small business owners in order to create a liquid income stream at retirement and arrange for an orderly transition to the new management of the company. Often, this management involves some of the family members of the owner. In addition, a small business person can gain a strategic advantage over competitors by using an ESOP to retire debt on a deductible basis.
Principal payments repaying a loan to a bank are nondeductible.
When an ESOP borrows money to acquire the employer's stock, the principal payments and interest to retire the debt are tax-deductible. This tax leveraging can give a small business a tremendous advantage which enables it to price its product more competitively to gain a larger market share. In summary, most small business people who use ESOPs do so for a combination of reasons. The primary reason is often to create a retirement income stream, find a market for illiquid closely held stock, and enable many key employees to afford to own a piece of the company.