Most business leaders explore an Employee Stock Ownership Plan (ESOP) with an initial focus on a tax-efficient exit strategy and succession plan that also supports a healthy future for the business.
But employees are important company stakeholders, too, and an ESOP’s benefits to employees are substantial.
How is an ESOP good for employees?
In short, an ESOP offers both tangible financial and intangible employee benefits, including:
- A retirement savings benefit that doesn’t require employees to contribute their own funds
- A stable and predictable transition that supports a sense of security at the time of company sale
- Ownership culture that promotes employee engagement, satisfaction, and retention
In this article, we’ll take a closer look at these three major employee advantages ESOP companies can deliver.
ESOP Retirement Savings Reward Employees
An ESOP is an Internal Revenue Code (IRC) section 401(a) qualified retirement plan. Unlike 401(k) plans and other similar qualified retirement savings plans, all ESOP contributions are made by the company — not employees.
Instead, over time in accordance with a documented vesting schedule, employees acquire appreciating equity in the value of the company. That company equity is expressed in terms of company stock ownership. Stock is held on behalf of employees by an ESOP trust, which is created at the time of ownership transition.
At retirement or termination of employment, the ESOP company repurchases the employee’s shares. The ESOP company’s distribution policy defines and documents when and how plan participants receive distributions, in accordance with IRC distribution requirements.
Many ESOP companies offer other qualified retirement benefits beyond the ESOP, such as a 401(k) plan. In fact, research shows that ESOP companies are more likely to offer secondary retirement benefit plans to employees than non-ESOP companies to have even a single plan offering. And ESOPs often find that employee stock ownership is a distinguishing benefit.
Research suggests that ESOP participants’ accounts have more than double that of participants in non-ESOP companies’ defined contribution plans. What’s more, ESOPs are required to include all employees that meet minimum service requirements. That means younger and lower-income employees who often miss out on defined contribution plans that require employees to defer income don’t miss out on ESOP benefits.
“When I’m trying to close an employment candidate, I save the ESOP discussion for the end. I simply ask if they would be interested in becoming a shareholder in Weidert Group, at no cost to them. The body language and facial expressions say it all!”
— Greg Linnemanstons, President, Weidert Group
ESOPs Offer Better Job Security and Stability
Job security and stability contribute a compounding benefit to employees’ ability to retire on time and financially on target. Losing a job means losing out on opportunities to contribute to retirement savings and, potentially, employer contributions … as well as those accounts’ chances to compound over time.
But work stability also makes a difference in the day-to-day lives of employees and their families. When a business owner decides to sell, the ownership transition can breed workplace chaos and uncertainty, sometimes resulting in turnover as employees worry about their future prospects under new management and look for jobs at other companies.
Selling to an ESOP provides a path to a smooth leadership succession, and the move toward employee ownership can help management strengthen employees’ sense of shared purpose. Communicating clearly and candidly throughout the transition helps employees recognize the benefits an ESOP company can deliver, embrace their role in contributing to company value, and stay with the company through the ownership transition.
Research shows that as of 2018, employee-owned businesses were 6.2 times less likely to lay off workers than conventionally-owned companies. A more recent study found that, while 12% of ESOP employees reported negative financial impacts as a result of the pandemic, almost a third of non-ESOP employees (32%) said the same.
ESOP Ownership Culture Supports Shared Success
What does ownership culture mean, and how does an ESOP benefit employees in terms of company culture?
In a word, it’s all about empowerment.
The ESOP ownership transition creates opportunities for employees to stay with the company, and potential to grow into leadership roles as the business moves forward. That sense of potential professional growth can promote worker retention over the transition and recruitment afterward. But ownership culture extends well beyond managers and key leadership roles.
In an ESOP, all plan-eligible employees become shareholders. That means better company performance can translate into a direct financial benefit to each employee-owner. This concept demonstrates the potential to create a virtuous cycle.
Engaged and satisfied employees have longer employment tenures, work more productively, and produce higher quality work. Those factors contribute to increased productivity, growth, and profitability — and when the annual ESOP valuation determines stock price, employees see in terms of dollars the impact of their work contributions on company value.
That financial outcome makes tangible all the intangible benefits an ESOP offers: engagement, productivity, employee longevity, and more. In an ownership culture, the company’s success is also the individual workers’ shared success.
Could an ESOP Benefit Your Employees?
It’s easy to start exploring the potential advantages an ESOP can deliver to your company and employees. You can start with a no-cost, no-obligation consultation with one of the experts at ESOP Partners.