- There are nearly 7,000 employee stock-ownership plans in the U.S., holding assets of $1.7 trillion, according to the National Center for Employee Ownership.
- More small to mid-size companies and some start-ups are looking at ESOPs as yet another attractive benefit they can offer job candidates in industries with high turnover rates.
- The Main Street Employee Ownership Act allows the Small Business Administration to make its loan guarantee programs more readily available to companies looking to transition to an ESOP.
In the ongoing battle to find and keep the best workers, here’s another tool more and more companies are considering: ESOPs.
Employee stock ownership plans allow businesses of all sizes — from S corps to C corps — to make employees the owners of the company. They also give business owners a way to sell their company without having to look for an outside buyer, or depend on the next generation of family to take over.
And now increasing numbers of small to mid-sized companies and some start-ups are looking at ESOPs as yet another attractive benefit they can offer job candidates. For industries with high turnover, such as hospitality and trucking, ESOPs can be an effective tool for recruitment and retention. After all, workers are more likely to stay when they know they have the chance to accumulate some significant wealth down the road.
Legislation signed into law this summer now makes converting to an ESOP easier. The Main Street Employee Ownership Act allows the Small Business Administration to make its loan guarantee programs more readily available to companies looking to transition to an employee stock-ownership plan. In the past these companies often had trouble getting loans through regular banks.
New York Sen. Kirsten Gillibrand, an early champion of the idea, came up with a bipartisan plan that had the best chance of passing. She and others recognized that employee ownership is one of the more effective ways for workers, who contribute to a company’s success, to actually share in its value as it grows.
“We talk about income inequality in this country, but ESOPs are a solution to wealth inequality,” said Keith Butcher, co-founder and managing partner of ButcherJoseph, an investment bank that specializes in helping companies transition to ESOPs. Butcher helped draft the recent legislation. “Over the long-term, employees can develop significant equity balances and really participate in the growth of the business,” he said.
And because workers have a financial stake in the success of the company, studies show that ESOPs are a great tool for retaining employees and motivating performance. In fact, nearly 75 percent of ESOP companies surveyed by the ESOP Association said they had better year-over-year performance as a result of their structure, and only 15 percent said they had worse performance.
The plans were formalized by Congress in 1974 when plan details were laid out in the Employee Retirement Income Security Act (ERISA). While some notable companies, like Wawa and Publix Supermarkets, offer them, they remain a modest part of total American stock holdings, at $1.3 trillion.
An easier process
The new legislation makes it easier for companies to get an SBA-guaranteed loan up to $5 million to transition to an ESOP. To qualify, however, companies must have been in business and profitable for at least three years.
Here’s how it works: A bank loans money directly to a business. That company then re-lends it to the ESOP. The ESOP is the entity that actually buys the business from the owner, making this an attractive way for entrepreneurs to exit their companies when they don’t have another generation to take over or don’t want to sell it to an outsider, said Butcher. Each year, the company makes a tax-free contribution to the ESOP, and the ESOP uses these dollars to retire the loan it took from the company. As the ESOP repays the loan, it releases shares to employees.
“We talk about income inequality in this country, but ESOPs are a solution to wealth inequality.”
Like other types of retirement plans, the employer’s contributions to an ESOP on behalf of employees are allowed to grow tax-free until the funds are distributed upon an employee’s retirement. At the time an employee retires or leaves the company, he or she simply sells the stock back to the company. The proceeds of the stock sale can then be rolled over into another qualified retirement plan, e.g., an Individual Retirement Account or a plan sponsored by another employer. Another provision of ESOPs gives participants — upon reaching the age of 55 and putting in at least 10 years of service — the option of diversifying their ESOP investment away from company stock and toward more traditional investments.
The financial rewards associated with ESOPs can be particularly impressive for long-term employees who have participated in the growth of a company. Of course, employees encounter some risks with ESOPs, too: Their retirement funds are invested in the stock of one company. In fact, an ESOP may become worthless if the sponsoring company mismanages the company and goes bankrupt. But history has shown that this scenario is unlikely to occur: Only 1 percent of ESOP firms have gone under financially in the last 20 years.
