Many business owners are still relatively unfamiliar with ESOPs. As the number of Employee Stock Ownership Programs continue to grow, companies are looking into the benefits of an ESOP.
An Employee Stock Ownership Plan (ESOP) is a profit sharing plan structured as a qualified defined contribution retirement plan. An ESOP invests primarily in company securities. Plan participants are employees who are allocated company shares to their ESOP account until they leave the company or retire. When the employee leaves or retires, they may receive either cash equal to the appraisal value of the shares allocated to their accounts or if they elect to receive the shares, the company will buy back the shares from the employee. Distributions generally are made over several years following the employee's departure.
An ESOP offers unique benefits to employees, owners, and to the company itself. A Rutgers University study found companies performed better as an ESOP-owned company when compared to their pre-ESOP period and other non-ESOP companies. According to the study, ESOPs showed increases in
- Employee retention
- Positive employee performance
- Employee empowerment
- Worker selection
- Company stability
Some owners are hesitant about handing over the company to an ESOP trust. However, a benefit of ESOPs for owners is the ability to transition ownership over time, allowing majority shareholders to maintain control of the business while overseeing the change. Unlike a sale to a third-party, an ESOP provides stability during the transition to prevent drastic changes in business operations or corporate culture.
Another valuable benefit of ESOPs is the tax savings associated with employee ownership plans. Qualified employer contributions are generally tax-deductible for up to 25% of payroll. Company owners may also be able to defer capital gains on the sale of their shares to the plan when proceeds are reinvested in qualified replacement property (QRP) within a year.
Business owners of small companies often think their company is too small for an ESOP. However, a number of small companies are turning to ESOPs with only about a dozen or so employees. The benefits and savings associated should be compared with the costs of implementing an ESOP. Lawyers experienced in ESOPs can give your company a good idea of how much an ESOP will cost your company and offer a clearer picture of the cost-benefits of employee ownership.
If you are considering eventual retirement from the day-to-day running of the company, an ESOP is a popular succession tool. When thinking about the costs of becoming an ESOP-owned company, these costs should be compared with alternative exit strategies. Selling to a third-party buyer or competitor may include broker costs, the sale price may be less predictable, and there may not even be a buyer interested in offering a fair price. “Selling” to an ESOP provides a ready buyer at a fair market value of the company.
If you have any questions about whether your company could benefit from an ESOP, the law firm of Butterfield Schechter LLP is here to help. We are San Diego County's largest law firm focusing its law practice on employee benefits law. Contact our office today with any questions on how we can help you and your business succeed.