What is an ESOP, and Can it Help Secure Your Company's Future?

What is an ESOP, and Can it Help Secure Your Company's Future?

Author: Josh Huseman, Vice President, Business Owner Advisory Services

As a business owner, an Employee Stock Ownership Plan (ESOP) can be an overlooked option that you may want to consider. ESOPs make it possible for employees to become stakeholders in the company where they invest their time and talents, and they provide business owners with a solid exit strategy.

According to The ESOP Association, over $1.3 trillion in value is held by employee owners through Employee Stock Option Plans today, averaging about $130,000 per individual. The success of ESOPs can easily be explained by exploring the many benefits provided to employees and business owner.

Advantages of an ESOP

In basic terms, an ESOP is a retirement plan. Because company owners fund an ESOP from business profits, no out-of-pocket commitments are required from employees. Regardless of employees’ ability to build an independent retirement fund, this gives them an opportunity to save for their future. In an ESOP, everyone’s work is integral to the profits of the company and ultimately their retirement.

Implementing an ESOP not only benefits employees but also can improve the financial performance of a company because employees have a vested interest in seeing the organization perform well. Research indicates that ESOP firms have a median value per employee of $89,000, compared with $69,136 for non-ESOP firms. Additional research indicates that employee retention rates are higher as well, with ESOP companies retaining staff at three-to-four times the rate of non-employee-owned companies.

While advantages like these can build a workforce more dedicated to ensuring a strong bottom line, an ESOP can also provide another option to an owner’s exit strategy. In some cases, an owner is able to create a ready market for selling the company and a smoother transition when the current owner is ready to retire.

Additional advantages include:

• Fair market value: Because the IRS and the Department of Labor require that ESOP shares be sold for fair market value, a business owner is able to receive an appropriate value for the company. Many owners think they may need to discount the value of their company when selling to an ESOP, and they are surprised to learn they can potentially receive the same amount as selling to an outside third party.
• Maintain a majority share: For business owners who may want to maintain a hand in business operations for a period of time, they can maintain a majority ownership by transferring less than 50% of the shares. This can be effective for owners who aren’t yet ready to fully transition.
• Time is on your side: As a business owner, you decide how quickly or slowly shares are transferred to employees, allowing you to exit when you choose.

There is a flipside. Business owners should be aware that ESOPs are subject to complexities, such as regulation and reporting requirements from the IRS and other government entities. As such, setting up an ESOP and maintaining it will require guidance from experienced professionals, so expect attorney fees and the like over the course of the agreement.

Is an ESOP Right for Your Business?

While many businesses benefit greatly from an ESOP, it may not be the right solution for every entity. An ESOP works best when company culture values employee contributions and fosters a family-type atmosphere. In this environment, owners can take pride and feel secure in transferring ownership of the company to dedicated employees.

ESOPs also work best when the management team already has a high level of delegated authority or when the owner has already begun personal responsibilities to talented staff. Doing so ensures a strong and vibrant leadership team upon succession, fully ready to take charge when the current owner is ready to exit.

If your company meets the criteria above, it could benefit from an ESOP.  

Whether you’re considering your transition today or years from now, reach out to the Business Owner Advisory Services team.

About the Author

Josh is the Vice President of Business Owner Advisory Services. Josh is motivated by a strong desire to see business owners impact the world through their core values and entrepreneurial spirit. He is particularly intrigued by the unique opportunities and challenges that come with family-owned businesses, and he works hard to help them realize their full potential.