Employee Stock Ownership Plans (ESOPs) provide companies of all sizes with tremendous benefits, including significant tax deductions for the company and allowing the business to remain intact following the sale. However, there are also risks involved with this shared ownership, and an ESOP structure is not appropriate for every company.
ESOPs were originally created as retirement benefits for employees, but ESOPs offer many benefits beyond those of other retirement plans. Selling to an ESOP creates an ownership culture where employees feel more motivated in their positions and committed to the business’ future success. Furthermore, studies have shown that ESOP companies tend to perform better after setting up the trust.
Engaging all full-time workers in an ESOP can help retain high-potential employees and recruit quality talent. Because stock ownership is typically based on length of service, employees are incentivized to remain with the company longer to gain more benefits.
Upon termination or retirement, employees are entitled to the value of their shares, and the ESOP must repurchase them from the employee. This is commonly referred to as a repurchase obligation. If workers leave their job for reasons other than retirement, death or disability, the company may delay the distribution for up to five years. The company must consider future repurchase obligations when structuring their ESOP.
Some owners express concerns that unqualified employees will assume control of the business. While employees will have company stock, they are not entitled to full ownership rights as other business owners. Specifically, they do not gain voting rights for major corporate decisions but are given certain financial information regarding their personal portfolio of shares.
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ESOPs are not intended for struggling companies. An ESOP company must be able to make timely loan payments and be prepared to fulfill its repurchase obligations. A company considering an ESOP should demonstrate stable growth. Wide fluctuations in revenue can put a company in a dangerous position with respect to its debt obligations.
As the management team generally remains in place following the sale to the ESOP, the selling shareholder should feel confident in the strength of the management team. In addition to their existing responsibilities, they should implement a plan to communicate the specifics of the ESOP structure to the employees.
Determining if an ESOP structure is appropriate for a company involves in-depth analysis of the company, and the shareholder’s goals. Engaging the services of an experienced professional is advised to perform this analysis.