5 Disastrous Mistakes to Avoid When Setting Up Your ESOPJune 12, 2017
ESOPs have a lot to offer businesses in need, but that doesn’t mean establishing a successful plan is going to be easy. As with most things in business, setting up something as complex as an ESOP requires extensive time, commitment, and research to do right. The transference of ownership is a serious issue and the implementation process deserves appropriate due diligence.
If you want to ensure your ESOP is both legal and able to offer you the benefits you’re seeking, remember the lessons learned from “The Tortoise and the Hare”: at the end of the day, slow and steady wins the race. Jumping in with both feet isn’t advisable when it comes to ESOP establishment, and moving too quickly can put your business at risk. Here are five big mistakes your company can’t afford to make.
1. Forgetting a Professional Valuation
Think your company is worth a lot? You’re probably right, but an assumption isn’t the same as a professional valuation. In order to ensure true market valuation is fair, realistic, and unbiased, a professional resource is absolutely essential.
Valuation drives the value of the stock you can sell to an ESOP, and this measure isn’t just for fun: it’s required by both the Internal Revenue Service and the Department of Labor. If you want your plan to succeed, you need to make sure valuation is handled by an experienced ESOP appraiser.
2. Choosing the Wrong Trustee
The trustee of your plan should be neutral, fair, and unbiased, providing oversight and administration that benefits everyone. Choose the wrong trustee, and you may find yourself with a loose cannon who can’t make beneficial decisions.
A trustee’s responsibility is to act solely in the interest of ESOP participants, not to eat out of the leadership’s hand. While a trustee willing to do whatever you want may sound like a good idea, the wrong choice could create a compliance nightmare. When you choose a trustee, do your best to choose wisely.
3. Leaving Out the Professionals
Unless you’re a CPA, an attorney, and a seasoned ESOP expert, setting up a plan all by yourself is going to be a near-impossible uphill battle. When you want to ensure all of your bases are covered, be sure to bring the right team of professionals along for the ride.
As a legal entity, an ESOP requires extensive professional guidance to keep your bases covered. Without someone experienced to help with the legal paperwork, tax accounting, implementation, and management, you may find yourself sinking money into an illegally established plan.
4. Omitting Tax Advantages
ESOPs have a lot to offer your business in terms of tax advantages, but these benefits won’t happen by themselves. Many owners who jump into ESOP implementation without taking the time to learn exactly what it takes to save may end up missing out on a lot.
Before taking out a loan and blindly buying stock, be sure what you’re doing is in your business' best interest. Sure, you are fully able to invest 29% of company stock into a C-Corp ESOP, but you’ll lose out on the tax perks available for contributions over 30%.
5. Subjectively Evaluating Your Business
As the owner of a business, you have a soft spot for the company you have created. You want to believe that your management team is the best of the best, your operations are consistently successful, and you have substantial income to justify the expense of an ESOP. And while there’s a good chance you’re right on the money with your perceptions of your business, it’s important to ensure rose tinted glasses don’t taint your view.
An ESOP is not the right option for everyone, and it’s important to look realistically at whether your company is a good fit. If there’s a chance you don’t have enough taxable income to benefit from ESOP tax breaks or your management isn’t all on the same page, you need to be able to pull the plug.
Setting up an ESOP can be a great move for your business, but there are a right way and a wrong way to go about getting started. With the right professional assistance and adequate due diligence, you can avoid these five disastrous mistakes when establishing your ESOP.
Written by Gary Canon