Let’s define ESOP!
ESOP is an acronym that stands for Employee Stock Ownership Plan, a strategy established in 1974 under the Employee Retirement Income Security Act (ERISA).
The primary goal of an ESOP, as a defined contribution plan, is provide a seamless transition during a succession, creating a trust on behalf of the company’s employees who are recognized as owners of the company stock. The trust enables them to acquire, hold, or sell company stock for their benefit.
As of 2018, it has been estimated that there are about 6,500 ESOPs covering 14 million participants. Participants in ESOPS do well, says the National Center for Employee Ownership (NCEO) with corroborating data from the 1997 Washington State Study that found that ESOP participants made 5% to 12% more in wages and had almost three times the retirement assets as did workers in similar non-ESOP companies.
What is different about ESOPs that make them successful?
Members of the management and leadership team remain in place during the process as ownership is shifted to the employees under a plan to invest in employee stock. To accomplish this, the company most often borrows from lenders, investors or selling shareholders in order to obtain the funds needed to enable the ESOP trust fund to purchase shares of stock. As the ESOP loan is paid, the shares are allocated to the employee accounts which they can exchange for cash (which can result in substantial benefits) when they sell their shares when they retire – or in the case of termination, disability or death.
Why is succession planning so important now?
Surveys and reports from the business community indicate a significant surge in retirement among the baby boomers, with some asserting that as many as 10,000 are leaving their careers every day. Many of these boomers serve on management teams and/or are business owners. As they consider a transition, their opportunities are varied. They may investigate arranging a sale to prospective buyers, such as competitors, third parties seeking to quickly build a presence in the sector, private equity firms, or even family members.
ESOP enables a smooth exit
With staggering numbers of retirements on the near horizon, many companies are seriously looking at their options. One of the most attractive transition concepts is to sell the company to the employees by using an ESOP.
While looking for a way to avoid the upheaval and negative impact that may result from an ownership change, companies may adopt a long term outlook that fosters confidence in employees, customers, vendors, investors and the community by giving ownership to the employees.
Research supports employee ownership as an important strategy. As a result of the flexibility of the process, the focus on consistency, and the presence of tax benefits, ESOP companies have proven to be more productive, have lower turnover, are faster growing and more profitable than other corporations.
What kind of companies can leverage an ESOP?
Interestingly, ESOPs are a popular choice for companies of all sizes, across all industries. There are some key distinguishing factors to consider.
For example, companies that have a reputation for effective leadership, a reputation for nurturing a culture of growth and innovation, a reputation for being employee-centric by rewarding and recognizing staff contributions, and a reputation for building a sustainable legacy, are most often the best fit for an ESOP.
Drawing on their strengths and stability while embracing consistency, these companies are highly valued and as such they present are a good opportunity for an ESOP to flourish.
To discuss if an ESOP is the best exit strategy for your organization, I invite you to call Ken Bagner or Liz Harper, at 973-994-9494.
