Evaluating employee stock ownership plans

According to the National Center for Employee Ownership, there are roughly 6,600 employee stock ownership plans (ESOPs) in the United States covering more than 14 million participants. Another 18 million Americans participate in other plans involving profit sharing and company stock, but ESOPs are by far the most common form of employee ownership.^{Disclosure 1}

An ESOP can help boost your company’s performance by providing your employees with an incentive to be more productive. They’ll share in your success and have the opportunity to put money toward their own retirement.

ESOPs carry several benefits for business owners as well. You’ll be able to liquidate stock without having to sell your company, and you, your business, and your ESOP will all reap tax benefits.

How does an ESOP work?

An ESOP purchases shares at fair market value from business owners and makes principal and interest payments using funds your company has contributed to the ESOP. In a leveraged ESOP, shares are purchased with borrowed money, and the entire cost of the loan may be tax-deductible.

Employees accumulate shares in their retirement accounts over time. When they retire from or leave the business, they get to cash in their shares.

Employees don’t buy stock. As their employer, you’ll allocate a specific number of shares to each eligible employee at no upfront cost. Allocation can be based on pay scale, terms of service, or other factors.

Shares are held in a trust account. When an employee exits, their shares are bought back by the company for further distribution among the rest of your employees. Your ESOP may own all of your company’s stock or only a small percentage.

When should you consider an ESOP?

As a business owner, you should start thinking about an ESOP when it comes time to sell your company or when you’re ready to begin planning for your retirement.

Let’s say you want to sell your business in 5 years, or maybe you think it’ll take that long to find the right buyer. Instead of waiting for a big pay-out, you can sell your shares to the ESOP trust and enjoy the proceeds while you continue working.

An ESOP increases the odds that your company will continue operating smoothly after you exit the business, protecting your employees’ jobs and careers. Employees at companies with an ESOP have retirement accounts more than twice the size of those elsewhere.^{Disclosure 2}

Would an ESOP be a good fit for your company?

Think of implementing an ESOP as slowly selling your business over time. Like any other potential buyer, an ESOP trust needs to ensure it’s purchasing a viable company at a fair price.

Utilize the same performance metrics that a purchaser, investor, or lender would use to evaluate your business. A feasibility analysis of your company should include financial performance indicators like your revenue, historic and anticipated profitability, and balance sheet strength.

Employee demographics also play a key role in your company’s potential viability. The fewer employees you have on staff, the more challenging it’ll be to make an ESOP work for your business.

As qualified benefit plans, ESOPs are governed by the regulations and minimum standards of the Employee Retirement Income Security Act of 1974 (ERISA), which protects employees against the misuse of their assets.

How do you launch an ESOP?

If your feasibility analysis confirms that an ESOP is a good option for your company, get an independent appraisal of the business to confirm your numbers and assumptions. Be sure to consult your advisors as well, like your accountant, attorney, and Truist relationship manager.

Establishing an ESOP involves:

• Securing a credit facility that enables the ESOP trust to purchase company shares. Corporate-owned life insurance can play a key role in ESOP financing and offer significant tax benefits.
• Selecting an ESOP trustee (an institution or individual) and establishing an ESOP committee to oversee your plan and ensure communication between the trustee and participants
• Integrating the ESOP with your existing retirement plans, including the possible suspension of matching or nondiscretionary 401(k) plan contributions
• Drafting documents to adopt into your plan
• Creating a comprehensive strategy to fully communicate your plan to all employees

Once your ESOP is up and running, you can administer it like other retirement plans, but keep in mind there are specific responsibilities pertaining to this type of plan.