Employee Stock Ownership Plans (ESOP) are best known for providing employees with the opportunity to become part-owners of the company they work for, improving productivity and commitment to the company. Less well-known is the fact that ESOPs are often used as an exit strategy for the owner of the company. There are numerous benefits of an ESOP for an owner, which is the focus of this post.
Why is it a Good Idea to Have an ESOP?
There are many advantages to forming an ESOP. Employers, employees, and the company itself all benefit in different ways. Employers have a guaranteed market for the sale of the business. ESOPs can also improve the company culture and, by extension, company productivity and market value by making employees part-owner of the company.
Employees benefit because the ESOP functions as an additional retirement savings vehicle at no cost to them. Employees are awarded shares based on a pre-determined formula which is usually based on longevity with the company and/or job position. This equates to a pre-tax, free retirement benefit from an employee’s perspective. As the business grows and profits increase, employees share in the wealth through increased shares and share values.
Finally, the company itself benefits from the ESOP. ESOPs can be used as a corporate finance tool to raise new equity capital or refinance outstanding debt. They can also improve cash flow when contributions are made in stock instead of in cash. Contributions are tax-deductible and the debt repayment can be funded with pre-tax dollars further improving cash flow and reducing tax liability.
These are just a few examples of the tangible benefits of an ESOP. There are intangible benefits as well, such as improved employee morale, productivity increases, reduced turnover, and employer peace of mind as they transition into retirement.
How Does an ESOP Work?
When a company forms an ESOP, it establishes an ESOP trust which is managed by an independent fiduciary. The company makes contributions to the trust either in the form of company shares or cash that is to be used to purchase shares from existing shareholders, the business owner, or lienholders in the case of a leveraged ESOP. The trust then distributes the shares to employee accounts. Employee contributions are funded entirely by the company. There is no cost to employees to participate in an employee stock ownership plan. Participants accrue shares over time. Upon retirement, quitting the company, termination, or death, employees can seek a distribution or payout if they are vested.
Learn more about how ESOPs work from the National Center of Employee Ownership (NCEO).
The Importance of an ESOP for Your Business
The benefits of an ESOP for the owner and employees aside, ESOPs are important for the business itself. As mentioned above, there are cash flow and tax advantages to forming an ESOP. C-Corps can make tax-deductible contributions to the ESOP. In an S-Corp, the portion of the business that is owned by the ESOP is exempt from taxes. Stock contributions are also tax-deductible since they are used to repay the ESOP loans.
ESOPs create an ownership culture that is also good for company morale, productivity, recruitment and retention. Company performance has a direct, tangible effect on employee benefits. A more profitable company translates into higher value or a greater number of company shares. Having this “skin in the game” can be a source of pride and strong motivator for employees to give it their all at work. As a recruitment and retention tool, ESOPs are unique in that they do not require additional contributions from the employee. In their eyes, their ESOP account is a free benefit that is typically offered in addition to a more traditional 401K plan, not instead of it.
Another intangible benefit with tangible effect is the way an ESOP impacts a business’ standing in the community. From a PR perspective, an ESOP provides incredible value. It demonstrates that the company is committed to its employees, not faceless shareholders, and also reinforces the company’s standing as a valued employer in the community. When an ESOP is formed, it is owned by the employees. That means the chances of the company sticking around for the long-term are high; this is a business the community can count on.
7 Benefits of an ESOP for an Owner
Business owners choose to form an ESOP for different reasons. Some of the most common reasons are:
- A controlled exit strategy that eases the transition to retirement.
- A built-in market for selling the business.
- A way to leave a legacy and ensure the business survives even after retirement.
- Deferment of capital gains taxes.
- Increase in personal liquidity, but still retain control of the company.
- Greater employee loyalty.
- Improved business productivity.
How This Employee Offering Benefits Owners as Well
ESOPs may appear to benefit employees more than employers, but dig a little deeper and we see how owners benefit just as much as employees. Owners gain a reliable, available market to sell their business, enjoy tax advantages and increased liquidity, and have more control over how the business is managed after the sale than they could ever hope to have in any other type of business sale. ESOPs are a true legacy option for owners who have invested their working lives in building a business and want to see it continue to thrive. There are even benefits of an ESOP for owners who aren’t facing retirement. These owners have an opportunity to build an ownership culture, attract better and more long-lasting talent, and employ people who are much more invested in the success and bottom line of the company than they would otherwise be.
Happy employees who are invested in the success of their employer make for a more pleasant working environment and a more profitable business. That is a win-win for everyone.
Is an ESOP Right for You? Contact Aegis Fiduciary to Find Out
ESOPs make tremendous sense for certain business owners and their companies. To learn more about the specifics of forming an ESOP and whether or not an ESOP makes sense for your business, contact Aegis Fiduciary to arrange a consultation. Our team of ESOP professionals is available for ESOP consulting, ESOP trustee services, and transaction trustee services.
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