The process of deciding whether your company is right for an ESOP is a good exercise. One that I recommend for almost all business owners I know.
If you’re thinking about an ESOP here are some things you should consider:
An ESOP is a qualified retirement plan. This means you will have both the IRS and The Department of Labor interested in your plan. The Department of Labor is primarily interested that all employees are treated fairly. This means that if you decide to install an ESOP in your company you will need to make sure it benefits all of your employees who are eligible and over 21 years old.
An ESOP is a great marketing opportunity. This doesn’t mean that you don’t walk your talk. An ESOP gives you the opportunity to share decision making (although you’re not required to do so) with all employees in the company. Some of the best ESOP’s I’ve seen are ones who share financial information with everyone. The companies with best practices also have an ongoing education program to teach financial literacy to all employees.
An ESOP can have significant tax advantages. An ESOP can have significant tax advantages for the selling owner. Depending on how the ESOP transaction is set up the owner can delay taxes for a very long time. If the company is a sub chapter S corporation the profits generated that are owned by the ESOP are also tax deferred.
If management wants to grow quickly or pursue an acquisition strategy an ESOP can help with making both a tax advantaged activity.
An ESOP is complicated. There are lots of moving parts in an ESOP that aren’t in other privately held companies. There is the ESOP itself, a statutory board of directors, an ESOP trustee, and an ESOP committee. All have to interact with each other in one way or another. We believe taking the extra time to set up successful ESOP’s can help with transparency in the company and makes for stronger relationships with all stakeholders.
ESOP’s work best with open book management. As mentioned above our thoughts are that the more information you share with all employees the more successful an ESOP company can be. According to the National Center for Employee Ownership ESOP companies tend to outperform their non-ESOP brethren in any particular industry. Many credit open book with management with being a major reason this happens.
An ESOP can be expensive. Setting up and maintaining an ESOP can be expensive. In many cases the cost of putting an ESOP in place and maintaining it is much less than the taxes that would have been paid. An ESOP will require an annual valuation, trustee fees, legal fees, and accounting fees that most private businesses won’t have. Managers of ESOP companies may just have to get used to things being a little more complicated, and can be more expensive than running a completely private company.
A successful ESOP will take management succession very seriously. Most ESOP’s have a hard time making generational changes in management. I believe this is because management of these companies don’t spend enough time thinking and training the next generation of managers. In my opinion if you want your ESOP Company to last you must train new generations of managers to take the place of older managers who will retire.
ESOP’s have many wonderful advantages. Management should know that they are not only working for their own benefit but the benefit of all employees at the company. If they remember these things they likely will have a successful experience.
A valuable tool in an ESOP company is a stay bonus for senior managers. I’ve written a special report on how a stay bonus can be used in a private company. Click on the button below to get your report.