By Bridget McCrea
With 78 million Baby Boomers gearing up for retirement and a much smaller group of Generation Xers following in their footsteps, many companies are looking for ownership transfer options that go beyond the typical “handing over the reins.” Having put their retirement plans on hold during the Great Recession – and now ready to rekindle those strategies – some of these owners are looking to Employee Stock Ownership Plans (ESOPs) as a viable option.
By definition, an ESOP is an employee benefit plan that is similar to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits.
Regulated by ERISA (The Employee Retirement Income Security Act of 1974), ESOPs are generally set up for the benefit of all employees. ESOPs may not discriminate as to which employees may participate in the ESOP and are subject to a vesting schedule. The company may contribute up to 25 percent of eligible payroll to the ESOP annually. Contributions are sometimes made in lieu of a 401(k) and sometimes as a complement to a 401(k) or profit sharing plan.
According to The National Center for Employee Ownership (NCEO) in Oakland, Calif., there are approximately 10,000 ESOPs in place in the U.S., covering 10.3 million employees (10 percent of the private sector workforce). In 2010, on average, companies contributed 12.7 percent annually to the ESOP, with 74.4 percent of companies contributing 6 percent or more annually and 46 percent contribute over 10 percent annually to the ESOP.
Companies can use ESOPs for a variety of purposes, most commonly to provide a market for the shares of departing owners of successful closely held companies; motivate and reward employees; or take advantage of incentives to borrow money for acquiring new assets in pretax dollars. In almost every case, ESOPs are a contribution to the employee, not an employee purchase, the NCEO reports.
To address the looming onslaught of Baby Boomer retirement, for example, owners of electrical distributorships can use ESOPs to create a ready market for their shares. Under this approach, the NCEO says, the company can make tax-deductible cash contributions to the ESOP to buy out an owner’s shares, or it can have the ESOP borrow money to buy the shares.
There are a few key rules to following concerning ESOPs. For example, when employees leave the company, they receive their stock, which the company must buy back from them at its fair market value (unless there is a public market for the shares). Also, private companies must have an annual outside valuation to determine the price of their shares.
In private companies, employees must be able to vote their allocated shares on major issues, such as closing or relocating, but the company can choose whether to pass through voting rights (such as for the board of directors) on other issues. In public companies, employees must be able to vote all issues.
ESOPs in Action
Todd Kumm, CEO at Dakota Supply Group in Fargo, N.D., has had an ESOP in place since the early-1990s. Established in 1898, the employee-owned company has 600 employees and 16 locations throughout Minnesota, South Dakota, and North Dakota, as well as five W.A. Roosevelt locations in Wisconsin. When the distributor’s current ownership took over in 1991 the company already had a modified version of an ESOP in place. That plan has since been developed into a full-blown ESOP that’s available to all employees who have worked for Dakota Supply Group for a year or more.
Kumm says the company’s ESOP is the “purest form” of such an organization because participants own 100 percent of the distributorship. “No stock is sold to outside parties,” he points out, adding that the ESOP is also fully mature, with any new stocks issued being generated by those individuals who left the company and subsequently sold their stock back. On an annual basis, Dakota Supply Group distributes profits to its employees. An outside company is brought in to evaluate the value of the company’s stock and that assessment is used to exchange those shares.
Kumm, who points to Border States and United Electric as two other NAED members who have ESOPs in place, says the strategy allows Dakota Supply Group to conduct long-term planning, knowing what human resources it will have at its avail and when. The plan also allows for the best possible employee reward program available: sharing in the profits of the firm that you work for. “Having an ESOP in place fuels growth because it keeps people reinvesting money in the company,” says Kumm, “and it also increases employee satisfaction.”
McCrea is a Florida-based writer who covers business, industrial, and educational topics for a variety of magazines and journals. You can reach her at email@example.com or visit her website at www.expertghostwriter.net.Tagged with tED