Give Your Company Away

For most business owners, the bulk of our wealth is tied to our companies. Financial planners readily bemoan the lack of diversification in our investment portfolios, pointing to the fact that we do not generate wealth by building a business. We actually generate wealth by successfully selling our businesses. As the baby boomer generation faces retirement, there is increasing concern with regards to turning the stock in our companies into cash. For most of us, an initial public offering is not appropriate. Unless one has a buyer standing in the wings, cashing out can be difficult.

The Evolution of the ESOP
The Employee Stock Ownership Plan, or ESOP, dates back to the 1950s, when lawyer and investment banker Louis Kelso developed the concept from his belief that the capitalist system would be stronger if all workers—as opposed to just a few stockholders—shared in owning the businesses they worked for. Currently the most common form of employee ownership in the United States, an ESOP is a benefit plan in which a company sets up a trust fund and contributes shares of its own stock or cash to buy existing stock. These contributions are tax de-ductible for the company. Shares are distributed to employees according to an agreed-upon formula, often based on the workers' relative salaries. Currently, there are approximately 11,000 ESOPs in the United States, covering over 10 million employees.

Is an ESOP for You?
A small percentage of GAWDA members have ESOPs. In the near future, as increasing numbers of baby boomers near retirement age, that number may see a dramatic increase.

In order for an ESOP to work, a company should be worth at least $2 million and should be fairly stable. It should be somewhat insulated from dramatic ups and downs. The owner of a company who sells his stock to an ESOP must understand that eventually he will transfer the control of his company to someone else. One cannot sell the majority or all of the company to the ESOP and remain in control of its future. Consider the following data provided by the ESOP Association:

• Approximately 95% of the association's members are private, closely held companies.
• ESOPs exist in large and small businesses—slightly more than half of the association's members have less than 250 employees.
• While ESOPs are prevalent in a broad range of industries, approximately 38% of the association's members are manufacturers; 13% of its members are distributors.
• Average annual sales revenue for members ranges from $5 million to $50 million.
• Nearly 80% offer a supplemental benefit plan in addition to the ESOP, including 401(k) plans, pension plans and profit sharing plans.
• 75% of the association's members report that motivation and productivity increase as a result of the ESOP.
• At least 75% of its members used borrowed funds to acquire the employer securities held by the ESOP trustee.

Corey Rosen, executive director of the National Center for Employee Ownership, details the growth of the Employee Stock Ownership Plan and what it can mean for your company. Read the story here.

How It Works
In order for the stockholder to get his cash out of the company, he sells a percentage of the company to his employees. The company borrows the dollars needed to finance the purchase and then lends those dollars to the ESOP, which then writes a check to the business owner. The company repays the loan by making annual payments through the ESOP, treating the payments as an employee benefit. With each payment, the appropriate number of shares is transferred to the individual employee's ESOP account. When the loan is paid off, the employees will own whatever share of the company is purchased, through the ESOP.

Just as in a 401(k) plan, the employee becomes vested and cashes out when he or she retires, is laid off, resigns or is terminated. At that time, the employee's shares are purchased by the ESOP, at its current value.

A Valuable Employee Benefit
As a compensation/retirement plan set up by a company and funded with its tax-deductible contributions, the ESOP can serve as a powerful recruitment and retention tool, especially for the smaller company that is competing for qualified personnel. Much has been made of the productivity and morale-enhancing aspects of employee ownership. A 2000 Rutgers University study found that ESOP companies outperformed both their own pre-ESOP operation and non-ESOP companies. The study reported that among 343 companies followed from 1988 to 1999, annual sales growth was 2.4% greater than what was projected. The average sales per employee also increased by an additional 2.3%. ESOP companies typically showed increased employment and added 2.3% more employees than were predicted prior to the formation of the plan.

Both the research and the number of participating companies suggest that ESOPs “work”; that is, they increase company productivity and strength through a sense of ownership, responsibility and accountability among employees.