Most business owners are vaguely aware that Employee Stock Ownership Plans (ESOP’s) can provide substantial tax advantages when they approach retirement, but they don’t have a clear idea of how ESOP’s work, nor do they realize how ESOP companies typically outperform non-ESOP companies.
How ESOP’s Work – According to information published by the National Center for Employee Ownership (NCEO), about two-thirds of ESOPs are used to provide a market for the shares of a departing owner of a profitable, closely held company. Companies set up a trust fund for employees and contribute either cash to buy company stock, contribute shares directly to the plan, or have the plan borrow money to buy shares. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan. Contributions to the plan are tax-deductible. Employees pay no tax on the contributions until they receive the stock when they leave or retire. They then either sell it on the market or back to the company, or back to the ESOP trust. Provided that an ESOP owns 30% or more of company stock and the company is a C corporation, owners of a private firm selling to an ESOP can defer taxation on their gains by reinvesting in securities of other companies. S corporations can have ESOPs as well. Earnings attributable to the ESOP’s ownership share in S corporations are not taxable.
How ESOP Companies Perform – A 2000 Rutgers study found that ESOP companies grow 2.3% to 2.4% faster after setting up their ESOP than would have been expected without it. Companies that combine employee ownership with employee workplace participation programs show even more substantial gains in performance. A 1986 NCEO study found that employee ownership firms that practice participative management grow 8% to 11% per year faster with their ownership plans than they would have without them. Note, however, that participation plans alone have little impact on company performance. These NCEO data have been confirmed by several subsequent academic studies that find both the same direction and magnitude of results.
How Employees Fare – A 1997 Washington State study found that ESOP participants made 5% to 12% more in wages and had almost three times the retirement assets as did workers in comparable non-ESOP companies. According to a 2010 NCEO analysis of ESOP company government filings in 2008, the average ESOP participant receives about $4,443 per year in company contributions to the ESOP and has an account balance of $55,836. People in the plan for many years would have much larger balances.
Legacy Advisors Group has experience working with ESOP financial advisors, bankers, attorneys, appraisers, etc., and can help you decide if an ESOP is right for your company. To learn more about ESOP’s and qualify for a complimentary, preliminary feasibility study, contact me at mertel@lmaallc.com
By: Mike Ertel, Transworld M&A Advisors