ESOPs: Debunking the Top 5 MisconceptionsMay 30, 2017
Whether as a benefit plan or a leadership transition strategy, employee stock ownership plans, or ESOPs, are increasingly common among companies from a wide variety of industries. In fact, as of 2015, the estimates nearly 7,000 plans in operation in the United States, and that number is only growing.
Despite this, however, many companies don't understand what advantages an ESOP structure has to offer. Members of executive leadership may believe that ESOPs are too expensive, or that keeping leadership within a company isn't advisable. Others falsely believe that establishing an ESOP means selling 100% of ownership overnight, or that selling to an ESOP means losing out on the potential for an increased valuation in a third-party sale. While there may be some validity to these assumptions under certain circumstances – after all, no business decision is right for everyone – many of these myths don't apply to businesses seeking an effective transition solution.
Here's the truth behind five of the biggest ESOP plan misconceptions.
Myth: "ESOPs primarily benefit employees, and my employees already have retirement benefits"
Reality: While ESOPs are often depicted as an employee benefit plan, this is certainly not the primary function. In fact, the reverse is true. An ESOP does offer some strong points to employees, but the true benefit is to the company owner and the company itself. ESOPs were created by Congress as a tool to encourage a business owner to sell to his employees. Realistically, ESOPs are corporate finance tools used in place of a merger or sellout, and any perks to a plan's participants are merely fringe benefits.
Myth: "I could get a better price selling to a third party"
Reality: Sellers need to focus on the after-tax proceeds they actually take home from a sale, not just the selling price. While the Company may bring more in the open marketplace, often the tax savings achieved through the sale to an ESOP can make up the difference. ESOP transactions guarantee the owner will receive Fair Market Value for his business. After consideration of transaction costs, the risks associated with bringing in outside buyers and the ultimate tax savings that can be achieved by selling to an ESOP, the “Better Price” argument often dissipates.
Finally, there's no guarantee that a third party will see the same worth you do. The process of a sale is often long and time-consuming, and when all factors are taken into account, there's a chance you could end up actually losing money in the long run.
Myth: "With an ESOP, I'll have to give up control to my employees"
Reality: In business, ownership and control are often intrinsically linked in perception if not in practice. With an ESOP, transferring ownership and relinquishing control can be synonymous, but this certainly does not have to be the case. Owners aren't the only professionals who have control in a company, and former owners who maintain an executive or director role are certainly able to continue to make decisions.
In addition, 100% of company stock does not need to be sold to an ESOP. Many plans are structured as partial buyouts and as little as 1% can be invested, preserving some or most of one's ownership percentage. However, a minimum of at least 30% may be required for certain C-Corp tax provisions, so many plans encourage selling at least this much.
Myth: "Using an ESOP gives employees voting rights"
Reality: Voting rights can be a big concern for owners considering ESOPs as a transition plan, but these worries are generally misplaced. While it is true that individual employees do vote in the case of major corporate events, voting rights associated with day-in and day-out corporate activities rests with the Trustee, not the individual employees. Further, owners can have a strong say in who will be appointed as a trustee, ensuring that the authority overseeing the ESOP has company and owner interests in mind.
Myth: "Using an ESOP means too much financial transparency for my employees"
Reality: Financial transparency – or lack thereof – among businesses is often a key point. In many cases, the only employees with visibility into financial statements are members of the finance team, with little to no access for anyone else. Due to the nature of an ESOP and the changing of ownership, many small business owners believe that employee ownership means access to proprietary information. However, this does not have to be the case. Nothing in the law requires financial details to be shared with plan participants, maintaining the integrity of your confidential data.
ESOP plans aren't necessarily cut and dry, and whether a plan will or won't work for your business is entirely circumstantial. However, debunking these common misconceptions can make it easier to come to the best possible conclusion.
Written by Herbert Kalman