Would Employee Ownership Better Your Business?
[February 2, 2020 Update: We have a more comprehensive version of this article available on this page.]
Deciding if an Employee Stock Ownership Plan (ESOP) is the right business strategy for you is a little more complex than just addressing some of the most frequently asked questions. There are of course pros and cons to every business structure, exit strategy, or succession plan. It’s important to talk to your advisors so they can understand your personal and business goals before setting off in any one direction.
As an ESOP, we’re happy to have a conversation with you and share our experiences regarding how employee engagement, culture, and business strategy have been affected at our firm since we became 100% employee-owned back in 2003. You will benefit from first-hand knowledge and expertise that comes from helping ESOP companies—and those considering an ESOP transaction—thrive financially and culturally.
FAQ: Is an Employee Stock Ownership Plan (ESOP) Right For Your Business?
1. What is an ESOP?
Simply put, an employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit plan designed to invest primarily in the stock of the sponsoring employer, providing employees with a beneficial ownership interest in the company.
2. Can my company become an ESOP?
Almost any corporation—public or private, large or small—can form an ESOP. Companies that may consider establishing an ESOP typically have strong cash flow, have borrowing capacity, and are not highly leveraged.
Some of the factors that must be looked at include:
- Cost of the plan relative to the benefits
- Company profitability and cash flow
- Succession planning
- Current/future corporate culture
3. What are the tax advantages of an ESOP?
While there can be great non-financial benefits to becoming an ESOP, there are some tax-specific and financial perks that can be realized.
- Contributions of stock and cash are generally tax-deductible.
- Similar to other qualified plans benefits are not taxable to the employee until distribution of the account.
- ESOPs that own S corporation stock are not subject to federal income tax (and generally no state income tax).
- C corporations are eligible for a tax deferral on the gain upon selling at least 30% of the outstanding shares to an ESOP (1042 transactions).
4. What are some other benefits of selling to an ESOP?
Beyond the financial and tax benefits of ESOPs, there are other benefits that range from soft (employee engagement and culture) to more strategic (succession planning):
- ESOPs can be a great way to preserve and enhance a company’s culture during an ownership transition.
- Studies have shown that ESOP companies typically have more engaged employees than non-ESOP companies.
- Selling to an ESOP can be an attractive succession plan to preserve company legacy.
5. How does an ESOP transaction work?
- Shareholders educate themselves on ESOPs to determine viability and interest level.
- Perform a feasibility study and evaluate alternatives.
- Choose a trustee.
- Determine financing sources.
- Negotiate terms and price between trustee (buyer) and shareholder (seller).
6. What is a feasibility study?
A feasibility study is conducted to help determine that the ESOP has the cash flow to repay transaction loans and addresses other pertinent issues. Feasibility studies will use company data to model post-transaction financial statements and will help identify the following:
- Extra cash flow the company has available to devote to the ESOP.
- Sufficient company payroll.
- Ability to handle short-term repurchase obligations.
If you have any questions about ESOPs or succession planning, you can reach Brian Sweeney at firstname.lastname@example.org or 651-407-5856. Or visit https://redpathcpas.com/industries/esop-companies/