One of the questions I hear most often from business owners is, “Should I consider an ESOP?”
An Employee Stock Ownership Plan, or ESOP, is one of the most powerful ownership transition tools available, yet it’s also one of the least understood.
While it isn’t the right answer for every company, it deserves serious consideration whenever an owner begins thinking about succession.
I often describe an ESOP as “going public – light.”
As with a publicly traded company, an ESOP requires a greater level of financial discipline, transparency and oversight. Independent valuations, regulatory compliance and ongoing administration mean the company will operate with a level of scrutiny beyond that of a privately held business.
That may sound intimidating but, in exchange, an ESOP can provide significant tax advantages and ownership structures that can be beneficial for both original shareholders and new employee shareholders.
Another similarity to a public company is that ownership becomes broadly shared. Instead of outside investors owning the business, the owners in an ESOP are the people who come to work every day – the employees.
That concept changes the conversation.
When employees become owners through their retirement plan, they aren’t simply collecting a paycheck. They are investing in the future value of the company.
And that naturally raises an important question. If we’re asking employees to invest their retirement in the business, what kind of growth can they reasonably expect?
Growth is essential to a successful ESOP.
One of the first questions any company should ask before pursuing an ESOP is whether it is truly positioned for long-term growth. Can the business continue expanding? Is there a clear strategy? Does management have the capability to execute it?
Those aren’t just questions for ownership; they’re questions that ultimately affect every employee-owner.
From the employees’ perspective, growth takes on an entirely different meaning. A new acquisition, an additional store or another expansion project certainly creates more work, but it also has the potential to increase the value of the company they own. Success is no longer just good for the business – it becomes good for their retirement.
For companies considering an ESOP, there are generally two paths.
The first is to establish the ESOP. That process usually begins with a feasibility study to determine whether the company is large and financially strong enough and positioned for sustained growth.
ESOPs have meaningful administrative costs and ongoing compliance requirements, so there is a practical size below which they often don’t make economic sense. Experienced ESOP advisors can help owners evaluate whether those conditions exist.
The second path is one that is often overlooked – selling the company to an ESOP organization.
In that scenario, the employees still become owners but do so by joining a company that has an established ESOP. The infrastructure, administration and governance are in place, eliminating many of the startup costs and complexities associated with creating a new plan.
In many cases, this can provide owners with an attractive exit strategy while giving employees the opportunity to participate in a mature and successful employee ownership culture.
Of course, an ESOP is not a panacea. It is one of many succession planning tools available to business owners. Depending on the goals, other ownership structures or buyers may ultimately be a better fit.
But for those wondering whether an ESOP deserves a place in the conversation, the answer is yes. It offers unique advantages, creates alignment between employees and ownership and, for the right company, can be an outstanding way to preserve a business while rewarding the people who helped build it.
As with any major business decision, the key is understanding the options before deciding which path best serves the company, employees and long-term goals.
Carey Berger is president, Business Service Resource Group.