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Employee Ownership and ESOPs: Why Small Business Owners Need to Pay Attention Now

Posted by Marc S. Schechter | Oct 01, 2018 | 0 Comments

Contributing Author: Gwenllian Kern-Allely, Law Clerk

In 2011, the baby boomer generation began turning 65. With the majority of businesses in the nation owned by persons over the age of 45, the number of business owners looking to retire in the next 15 years could place over $10 trillion in assets for sale. In California alone, over 12 million businesses will be for sale in the next 10 to 15 years.[1]

Extend the Legacy

Employee ownership presents a solution to the problem of lost assets by allowing small business owners to create a succession plan or market for their shares that keeps the jobs in the community while retaining the legacy of the business developed by the owner. The encouragement and promotion of employee ownership is a way to retain and create jobs, as well as increase wealth for workers and expand economic growth.

Conserve Jobs

As the massive sale or liquidation of businesses looms, employee ownership plans become more appealing. Employee ownership permits employees to keep their employment in a job they already have – reducing unemployment as well as other turnover that can cause business turmoil. The retiring business owner knows the business will be left in the hands that have helped care for it – giving the employees the chance to continue working at what they already know and without the added stress of having to find new skills or learn a new trade in a new sector. Employee owned companies have been shown to weather economic downturns more effectively than non-employee owned companies, in addition to demonstrating higher levels of productivity.

Plan Now for the Future

Employee ownership has many forms, with one of the most prominent being Employee Stock Ownership Plans, or ESOPs for short. An ESOP is a qualified retirement plan under the Employee Retirement Income Security Act (“ERISA”) of 1974. An ESOP allows a business owner to not only plan for his or her retirement, but also create retirement opportunities for his or her employees. Currently, there are around 7,000 ESOPs in the nation.

At this time, the majority of business owners do not have a succession plan in place. With the 2018 average annual social security benefit estimated at $17,040,[2] it has become extremely important for business owners to retire well. ESOPs provide the opportunity for not only the business owner to retire well with the value of his or her business, but also creates a retirement plan for the employees that will ensure their continued employment and their ability to retire well.

An ESOP is a trust that is established by the company, typically through a bank loan or the selling shareholder taking back a promissory note for the sale of their shares. The trust then buys a portion, or all, of the company's shares after an independent appraisal and valuation of the company. As the loan is paid off, shares of the company are allocated to the employees, and vest over a period of time. When the owner retires, he or she can sell the remaining shares to the trust. Some of the ESOP other tax benefits include no taxation on employee shares until they are distributed to the employee and tax deductible repayment of the loan by the trust and the company. Additionally, both C-corporations and S-corporations receive a variety of favorable tax treatments for an ESOP.

Reform Needed

At this time, California does not have any favorable ESOP legislation (except for a selling shareholder to defer their tax on certain stock sales to an ESOP) and has very little educational materials available for business owners regarding employee ownership. At a time when most business owners will be looking to retire and have no succession plan in place, this places California businesses and business owners in detrimental positions. Without the proper information on the benefits of ESOPs as retirement plans or other forms of employee ownership, a business owner is likely to retire by liquidating or selling his or her business. In this scenario, the employee jobs are no longer secure, and the lifetime of work by the business owner may cease to exist with little remaining evidence of what the business had accomplished.

[1] California Association of Business Brokers. https://cabb.org/news/baby-boomers-incredible-numbers-are-buying-and-selling-businesses-part-1-2

[2] Social Security Administration. “2018 Fact Sheet.” https://www.ssa.gov/news/press/factsheets/colafacts2018.pdf

About the Author

Marc S. Schechter

Marc Schechter specializes in the areas of employee benefits, ERISA, and business matters.

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