The Value of an ESOP

When a business owner contemplates selling, their concerns extend far beyond the sale price. A major emotional barrier is the potential impact on their legacy and their long-time employees.

The owner often views these employees like family, bound by years of shared struggles and successes.

The deepest fears when searching for a buyer include:

• Employee Welfare: Will a new owner conduct massive layoffs, particularly of dedicated, long-term staff?

• Business Legacy: Will the company's local identity and hard-earned reputation—its role as a good corporate neighbor and community pillar—be maintained or will a new owner simply close the location and merge it elsewhere?

These anxieties weigh heavily, often making the sale process more about finding a responsible steward than just getting the best sales offer.

An ESOP is an ideal way to share the wealth of a company with its employees

Employee Stock Ownership Plan

An employee stock ownership plan (ESOP) is a qualified retirement plan, much like a 401(k), but with a critical difference: it's designed to buy and hold the company's stock.

Here's a breakdown of how it works:

• Fiduciary Trust: The ESOP is set up as a fiduciary trust funded by the company, which ensures it must act in the best financial interest of its participants.

• Company Stock: The trust exists to legally hold and accumulate company shares on behalf of the employees.

• Beneficiaries: This structure makes the employees the beneficiaries of the trust. When an owner sells to an ESOP, they are essentially selling the company to a trust that is legally bound to represent the future wealth and welfare of the employees.

By selling to an ESOP, the owner preserves the company's identity and legacy, securing a built-in buyer whose interests—the employees'—are directly tied to the company's ongoing success and stability.

Currently in the US, there are nearly 6,400 ESOPs in existence, representing nearly 15 million employees. Although ESOPs are more prevalent in manufacturing and professional services, they do exist across all industries. Some well-known companies that have ESOPs include Gore-Tex,  Publix Supermarkets, Discount Drug Mart, Davey Tree, New Belgium Brewing, Robert W. Baird, and Black & Veatch.

Employees earn the rights to allocated shares based on a schedule. This process is known as vesting. However, unlike publicly traded stock, the employee cannot sell the stock whenever they choose. The company must buy back the vested shares of the employee when they leave employment, retire, or become disabled. The company, relying on an independent appraisal, will pay the  current fair market value of the shares.

Why an ESOP is Good for the Business Owner

There are several factors that are advantageous for the owner:

• Legacy & Succession: Creating an ESOP allows the owner to sell their ownership stake at a pace that suits their interests. This provides them with a ready buyer ( the employees of the company), as well as preserving the company culture and location, avoiding the risks & disruption of selling to a competitor or being bought by a private equity firm.

• Tax Advantages: Depending on the company’s legal & tax structure, these include:

  - Tax-Deferred Capital Gains:  For C-Corporation owners who sell at least 30% of their stock to an ESOP, capital gains tax on the sale can be deferred (or potentially eliminated) by reinvesting the proceeds in U.S. securities.

  - Tax-Free S-Corporation Earnings: A 100% ESOP-owned S-Corporation effectively pays zero federal income tax on its share of the profits. This creates powerful cash flow for the company.

  - Pre-Tax Dollars: In those instances where an ESOP used a loan to purchase stock to fund itself, the company is able to use pre-tax dollars to repay the loan.

Why an ESOP is Good for Employees

By its nature, employees are invested in  the company’s success beyond just a weekly paycheck. Many companies with ESOPs recognize that they must empower employees to play a role in some level of workplace decision-making and financial transparency.

For employees who retire, the retirement benefit is often a substantial dollar amount that they receive at no cost to themselves. One analysis indicated that is common for an ESOP payout to be worth $300,000-$500,000. This payout is often an extra benefit, with nearly 90% of ESOP companies offering an additional retirement plan such as a 401k.

Why an ESOP is Good for the Business

Compared to non-ESOP companies, research has shown that ESOP companies have higher productivity, faster growth rates, and lower employee turnover. Statistics include:

• A Rutgers University analysis indicated that sales per employee were 2.5% higher than non-ESOP companies

• ESOPs report that the voluntary quit rate of employees is one-third of the national average

• Productivity growth rate of ESOP companies grew by 52% in their first year after the ESOP was initiated.

Conclusion

Starting an ESOP can be a costly, complex  and time-consuming process. However, an ESOP stands as a proven solution to a dilemma that a business owner faces: How to achieve a profitable exit without sacrificing the company's legacy or the welfare of long-time employees.

An ESOP is far more than a financial transaction; it is a declaration that the company's future belongs to the people who built it, ensuring that the legacy of success continues to enrich the employees and the community into the future.

With any thoughts of a business exit, a team of experts is necessary to help council a business owner on the steps and decisions that are necessary.   At Generosity Nexus, we have a track record of guiding business owners on a variety of exit strategies, and the role charitable planning can play in making a greater impact. Don’t hesitate to schedule an appointment to learn more about how we can help you.