Is a 100% ESOP Right for You?Tweet
You don’t have to look far these days to find a company with a 100 percent Employee Stock Ownership Plan (ESOP) structure. In recent years, the tax free nature of this model combined with a high degree of visibility has made them a standout among many available alternatives. Numerous companies have taken the step to a 100 percent ESOP from 30 or 40 percent plans, and even more from scratch. For those who are currently considering the transition to a 100 percent ESOP structure, it does bode the question, “Just because I can do a 100 percent ESOP, is it right for me?” While a 100 percent ESOP might be the right fit for many companies, in actuality, as with all decisions that dramatically impact the future of your company, 100 percent ESOPs should only be considered under the guidance of an experienced advisor and after a thorough understanding of your business, your goals and the best options unique to you.
An ESOP is a trust set up by a corporation to allot some of its stock to its employees over time. It’s similar in many ways to a profit-sharing plan. Shares are allocated to individual employee accounts based on their compensation levels as well as how long they have worked for the company – as employees accumulate seniority, they become increasingly vested in the account. In addition to enhancing overall employee performance and morale, ESOPs can be used for many purposes, including ownership/management succession strategy, employee benefit plans or as a component of a complete leveraged buyout. They can also create a market for inside or outside shareholders and raise capital to finance corporate acquisitions, refinance debt or other initiatives. With increasing frequency over the last five years, many companies have been driven by the tax benefits associated with S-Corp ESOP companies, leading them to a 100 percent ESOP ownership option.
Benefits of Going All In
The recent trend toward 100 percent ESOPs has been fueled by several elements, both economic and emotional, led by the well-known tax benefit. In an S-Corp ESOP, the ESOP trust is exempt from taxes. At a glance this reality is extremely compelling. The company makes money but doesn’t pay taxes and the company retains all the cash to allocate to various initiatives.
Culturally, a 100 percent ESOP puts full leverage behind the idea that having a sense of ownership incentivizes employees to work harder for a company that is their own. Realizing their individual stake in the outcome, employees often respond to ESOP plans with increased performance and morale. This is one of the less tangible, albeit significant, motivators that business owners recognize when considering both partial and 100 percent ESOPs.
From an emotional perspective, many owners of closely held businesses considering a 100 percent ESOP prefer the idea of their business being owned internally by employees, rather than sold to a third party. While they might not make any more money at the outset, owners like the notion that if their employees hang onto the business as an employee-owned S-Corp, they might have some exceptional value appreciation relative to what they might have otherwise had. This can be a significant factor that drives many decisions to go to a 100 percent ESOP.
While a 100 percent ESOP might or might not be right for your company, there are a myriad of alternatives or hybrids of solutions that can generate the outcome you are looking to achieve. The most important step is beginning the process with the insight of an unbiased, experienced consultant such as Prairie Capital Advisors to help you explore your best options.