Employee stock ownership plans (ESOPs) can have substantial benefits for companies and employees. These qualified retirement plans give employees an ownership stake in a company by providing them with shares of stock. ESOPs are becoming more popular among Florida companies, and with good reason. According to the National Center for Employee Ownership, there are close to 200 employee-owned businesses in Florida.
If you lead a growth company in Florida and are thinking about setting up an ESOP for your employees, here’s how it works, how to finance and structure your ESOP and why this type of plan could be beneficial for your business.
An ESOP is a special type of qualified retirement plan that allows employees to take ownership in company stock. It works differently than a 401(k), which typically offers a selection of investments through an employer-sponsored retirement plan.
The first ESOP dates back to 1956 when attorney and economist Louis O. Kelso created this mechanism as a succession planning tool. The goal was to transfer ownership of Peninsula Newspapers, which at the time, was owned by two co-founders, to managers and employees of the business.
Since then, ESOPs have become a popular tool, not just for succession planning but also for attracting and retaining talent. Offering stock options can provide incentive for top talent to join your company, and it can also encourage loyalty and hard work as employees may feel more invested in your company’s success. Your business can also benefit from lower employee turnover.
ESOPs can have a few different structures, though the most common are leveraged and non-leveraged. As mentioned, some may also combine features of an ESOP and a 401(k). Here’s how leveraged and non-leveraged ESOPs differ:
Leveraged ESOP: With a leveraged ESOP, a company takes out a commercial loan to finance the purchase of stock shares to contribute to the trust. The shares then serve as collateral for the loan until the company repays it. ESOP financing is a popular option for newer or growing companies, as creating this type of plan has a relatively high upfront cost.
Non-leveraged ESOP: Non-leveraged ESOPs work differently. With these plans, companies buy shares directly using existing funds and then add those shares to the trust. Generally, companies contribute new shares on a yearly basis.
Depending on how your company is structured, an ESOP may also give you tax benefits. For instance, S corporations owned by an ESOP may be exempt from certain taxes on company earnings. Theoretically, a company that’s 100% employee-owned could be exempt from income taxes altogether. Likewise, C corporations with an ESOP could defer capital gains taxes in some cases and employee-owned C corps may also be eligible for additional tax deductions.
Structuring an ESOP tends to be complicated, so consulting with a benefits or investment expert is a wise move. Here’s what you’ll need to think about to properly structure your ESOP.
Legal considerations: ESOPs are structured as a qualified retirement plan, and thus need to abide by related federal laws, including the Employee Retirement Income Security Act (ERISA). A key part of this is having a fiduciary manage the plan. This person must act in the best interests of the beneficiaries and participants. Either the plan manager or someone at your company will also need to ensure regulatory compliance and accurate record keeping.
Plan document: This document serves as the road map for your ESOP and details things like the employee vesting schedule — many companies have a four-year vesting schedule for ESOPs — which employees are eligible, and rules related to allocation and distribution.
Valuation: Company valuation also plays an important role in ESOPs. Typically, companies work with an independent valuation firm each year to determine the market value of the shares held in an ESOP. Increases in valuation can mean higher account balances for employees. Conversely, decreases reduce balances.
Here’s a basic look at the process of implementing an ESOP.
1. Determine if an ESOP is right for your company: Evaluate things like company size, where you are in your growth trajectory, your finances and your goals.
2. Meet with an attorney and investment advisor: If you determine an ESOP is the right choice based on your assessment, you’ll want to meet with an attorney and investment advisor for guidance on developing a plan document. Discuss things like employee eligibility, rules around allocation and distribution, vesting and ESOP lending or funding.
3. Create a plan document: Create a plan document outlining all the details of your ESOP.
4. Hire a plan manager: Identify a plan administrator who will act as a fiduciary and manage things like regulatory compliance, asset management and coordinating company valuation.
5. Work with an appraiser: Once your plan manager is on board, you’ll want to coordinate with an independent valuation firm to determine the market value of your company shares.
6. Shore up regulatory compliance: Finally, work with your plan manager to ensure that your ESOP is in compliance with proper regulations.
Unlike 401(k)s or pension plans that typically invest in mutual funds or diversified assets, ESOPs are designed to hold shares of the employer’s own stock. This structure not only gives employees a direct ownership stake in the company, but also aligns their financial interests with the company’s performance.
ESOPs don’t generally serve as a standalone retirement savings plan, though they can be beneficial for employees. These plans let participants invest in the stock of the company they work for, and as the company thrives and grows, the value of their shares grows too.
An ESOP can set your company apart from competitors in attracting and retaining top talent. This type of plan, which could help improve your talent pool and spur ongoing business growth, is an enticing perk for job seekers.
ESOPs may also serve as a motivator for employees, as they’re more invested in the success of the company. You could end up with a more productive and aligned team. A plan like this may also help reduce turnover at your company, especially if you offer generous stock options. This can be a major benefit for team members.
Creating an employee stock ownership plan for your business can be a complex process. Consulting with an attorney and investment advisor for guidance can make it easier to create and manage an ESOP. Despite an upfront investment of time and money, the long-term benefits for your business and employees will likely outweigh any initial implementation headaches.
An ESOP can help you attract and retain top talent, while simultaneously building a more engaged team. If you’re interested in learning more about employee stock ownership plans, you can request a meeting with an advisor by completing the form below.
Topics: Building Your Team
Equal Housing Lender. Member FDIC. NMLS# 608046
Share: