Q: We have a sizable agribusiness with a number of employees. In a recent discussion, our accountant suggested we consider using an ESOP [Employee Stock Ownership Plan] to help transition my father out of the business. My understanding is an ESOP will provide him cash for retirement, yet allow us to retain the operation. What is an ESOP and how does it help to plan for succession?
A: Simply speaking, an ESOP is a qualified defined contribution retirement plan that invests in the
stock of the sponsoring company. Participants in the company’s retirement plan (employees) become owners of the organization by investing their retirement money in company stock. Since it’s a qualified plan, an ESOP is governed by strict laws of the Employee Retirement Income Securities Act.
Common sense and a number of studies suggest that employee ownership tends to increase productivity and profitability. Ownership generates pride and improves employee morale. It can increase employee retention and attract new hires.
On the other hand, and from the employee’s perspective, ESOPs concentrate their retirement savings in the stock of a single company—the same company he or she is already dependent on for wages and benefits.
Pros and cons. There are different attributes and concerns for both current owners and employees when it comes to using ESOPs for prospective owners and succession planning.
The first step in the process, as in all succession planning, is to define your objectives and conceptualize the desired outcome. In other words, does an ESOP help you achieve your succession planning goals?
Be mindful, using an ESOP ensures that some of the owners will be employees of the organization and not related to the family. Assuming that’s part of your objective, or at least a reasonable compromise given your circumstances, it might help to review these questions:
- Is it our intent that retiring owner(s) sell a portion of their stock to the ESOP? In using an ESOP an owner might still retain some portion of their holdings to pass to a successor(s) as part of the transition.
- Is it our intent that retirement plan participants who are not necessarily part of family and/or the management team acquire ownership of the company? Though maybe not ultimate control of the operation, an ESOP will grant employees a voting interest in the major decisions.
How will it work? If you answered yes to the above questions, an ESOP can be a useful tool when planning for the future of your business.
The planning process should start with a clear understanding of the business’ current ownership structure and a good idea of what that structure will look and act like once the plan has been fully implemented and the ESOP is in place.
A major distinction that will affect how the succession plan is executed is whether the current owner(s) intend to:
- remain with the business for awhile to implement the plan, or
- sell their interest to the new owners and allow them to handle the details of the transition.
For succession planning, an ESOP creates a ready market for stock of a corporation. It provides cash to the retiring owners while transitioning ownership to employees who, in turn, care about the future of the company and accept the responsibility.