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Employee Stock Ownership Plans (ESOPs)
Understanding the value of this exit strategy and incentive program
Employee stock ownership plans (ESOPs) may be a powerful alternative for middle market business owners who think that private equity or other outside buyers are their only exit strategy. ESOPs are not well understood, but among companies that understand ESOPs and their benefits, they are proving to be an increasingly popular option.
Many business owners understand the basics. An ESOP is an equity-based retirement plan that allows employees to become owners in the company. Ideally, this creates an incentive to think like an owner and contribute to the success of the organization. But many business owners have misapprehensions concerning the transaction, an ESOP’s impact on corporate governance and other issues.
Following are some common ESOP questions.
- How is an ESOP different from selling the company to others? One of the big advantages to an ESOP is that owners can sell any percentage of the business. Another unique aspect of an ESOP is that C corporation owners selling to an ESOP can reinvest the sale proceeds into qualifying securities and defer tax on the gain from the sale if the ESOP owns 30 percent or more of the company stock. Other differences also exist, including the company culture post sale.
- Which employees participate? Unlike equity compensation programs that are narrowly targeted at executives and other key players, ESOPs must be available to a broad group of employees, typically similar to participation in a company’s 401(k) plan. In most ESOPs, though, contributions are entirely funded by the company rather than employee contributions.
- Is this going to create a governance headache? ESOP shares are voted by a plan trustee, not individual employees, except in certain large transactions. The trustee does have a fiduciary duty with respect to the plan’s investment in the company stock, but the company’s board is still in place, and management still runs the day-to-day operations.
- Do ESOPs work with small companies? Companies with as few as 20 employees can have successful ESOPs. Rather than size, financial stability, good management, company culture, and appreciation for the ESOP are more important to achieving value from an ESOP.
For business owners looking for an alternative exit strategy, an ESOP can be an attractive option. The new owners are already invested in your strategic approach and company culture. As with any plan, there are expenses, both in the initial transaction and for the ongoing administration of the plan. In addition, there are unique regulations you should understand and consider.
How we can help
With hundreds of ESOP clients, RSM offers proven experience with the full range of structuring and compliance issues related to employee ownership. We help clients evaluate the potential costs and benefits of an ESOP, provide consultation on structuring to meet management and financial needs, and address questions on DOL and IRS regulations and compliance.
Learn more about our capabilities.
Employee stock ownership plans can be attractive to business owners, employees and companies overall. Learn how each stakeholder benefits.
RSM provides answers to some of the commonly asked questions regarding employee stock ownership plans (ESOPs).