Employee Stock Ownership Plans
One of the biggest challenges when running a business is motivating employees. This can be especially important in a smaller business where one employee can leave a large footprint. Giving employees a raise helps, but that can be costly and not practical for some small businesses. A better way is aligning long-term goals for both the company and labor. There is no better way to motivate an employee than offering skin in the game. In this case, skin refers to equity ownership. A growing way small and medium-sized businesses are choosing to award ownership privileges to workers is through an ESOP.
What is an ESOP?
An employee stock ownership plan, or ESOP, is a tax-qualified, employee benefit plan that allows employees to become shareholders in the company they work for. It is generally designed for privately held companies and requires the plan to invest a significant amount of the assets in the sponsored company, the employer. ESOPs are also utilized by publicly traded companies but these represent less than 3% of all ESOPs.1
While ‘ESOP’ is not a household term, it is widely adopted. There are around 10,000 ESOPs nationwide representing over 10 million working Americans.2 The largest ESOP in the country is Lakeland, Florida-based Publix Super Markets, with roughly 160,000 employees participating in the program.3
The largest ESOP in the country is Lakeland, Florida-based Publix Super Markets, with roughly 160,000 employees participating in the program.3
Setting up an ESOP
Creating an ESOP for your company may seem like a no-brainer but there are several factors that must be evaluated prior to implementation. How will the stock be allocated to employees? Who will buy the employee’s stock when they retire? What about the vesting period?
There are a few requirements that a private company must meet when establishing an ESOP. First, an ESOP must be set up by a qualified consultant. Second, the company needs to be appraised by an independent valuation expert. Finally, the company must assess the impact an ESOP may have on current shareholders since an ESOP could result in substantial dilution for existing shareholders.4
Of course, the company must also prepare to meet redemptions by employees whenever they leave the company. This is known as the “repurchase obligation”. Employees essentially have a put option when they leave the company-meaning they have the right to sell their shares at the current valuation (price).5
The company puts money away for future repurchases, either in the form of stock and cash contributions or the purchase a type of business insurance. An attorney typically finalizes the ESOP implementation.
Benefits of an ESOP
- Any employee benefit plan increases employee morale, allowing employees to share in the pride of business ownership.
- The majority of the companies on the Forbes ‘Best Companies to Work For’ list have broad employee benefits packages, such as ESOPs.6
- These plans unlock the productivity in their employees. A 2000 Rutgers study revealed companies with ESOP plans grow between 2.3% and 2.4% faster than their non-ESOP counterparts.7
- ESOPs provide an exit strategy for a privately held company. About 2/3 of ESOPs are used to buy out a retiring owner.8 It provides an alternative to selling the business completely.
- ESOPs are a flexible liquidity strategy that can use pre-tax, future earnings to buy shares from an owner.9
- Also, many ESOPs can borrow money in a very tax-advantaged manner, essentially deducting both principal and interest.
- So-called “leveraged ESOPs” can be used for mergers and acquisition (M&A) transactions. One example is divesting a division within a company. The division will essentially be spun-off into a newly created shell company, which the ESOP will purchase.
- Not feasible for very small companies since it typically costs at least $40,000 to initially set up.10
- Plans administrators may also charge annual fees of between $15,000-$30,000.11
- The repurchase obligation can also be quite expensive for private companies.
- The plans can be complicated and continuing to issue shares can dilute existing holders.
- ESOPs cannot be set up for partnership structures.
Who Implements ESOPs?
A small, regional investment bank will typically set up an ESOP for a company. They have the resources necessary (analysts with valuation expertise, attorneys on staff, experience) to implement an ESOP or use one to execute a particular strategy.
Investment Banking Degrees
The example above shows that while landing a Wall Street job in investment banking can be very challenging, there are different routes a financial professional can take to become an investment banker. An advanced degree such as an MBA or a Masters in Finance will be looked upon quite favorably by potential employers. Given the quantitative aspects of some investment banking positions, pursuing a Masters of Accountancy (MAcc) degree could also be helpful, especially given the detail and financial complexity that projects, such as ESOP implementation, can entail.
Finally, pursuing the prestigious Chartered Financial Analyst (CFA) designation could help any aspiring banker to get a foot in the door. Some Masters programs even prepare ambitious candidates for the CFA program whose curriculum follows the CFA guidelines.