What is an Employee Stock Ownership Plan (ESOP)?
ESOP stands for Employee Stock Ownership Plan. An ESOP is a qualified retirement plan that can be used as a business transition tool and as an employee ownership vehicle:
“Live your values. If you don’t know what they are, go find out.” -Art Barter
When an organization develops a culture based on a strongly held and widely shared set of beliefs that are supported by the business strategy, amazing things happen. Based on an extensive study, employee ownership increases sales 2.3 to 2.4% per year over what would have been expected without an ESOP (Employee Stock Option Plan), reports the National Center for Employee Ownership (NCEO).
Business succession planning will be critical for numerous businesses as approximately 10,000 Baby Boomers reach age 65 on a daily basis according to a Pew Research study. According to this study published in December of 2010, by 2030 all Baby Boomers will be at least age 65 and will represent approximately 18% of the nation’s total population.
Many business owners may wonder, “What is an employee stock ownership plan (ESOP)?” This a common question from business owners seeking business succession plans as a method for liquidating their equity in the business while maintaining the culture and values of the company they built during their working years.
Many business owners that have implemented or are exploring an employee stock ownership plan (ESOP) may not have an active Board of Directors in place. Often times the Shareholder(s) are operating as the Director(s) of the company as they manage the day-to-day operations, and are not separately meeting as a Board to formally achieve the Corporate Governance responsibilities of the Board. Of those that do have a functioning Board, many operate the Board as an extension of the senior management team to make short-term operational decisions, rather than long-term, strategically focused decisions in line with corporate governance best practices.
At the time a business owner or company begins the process of exploring an employee stock ownership plan (ESOP) as a component of their Business Succession Plan, many have never established a functioning Board of Directors. More often than not, the shareholder serves as the only member of the Board, while also serving as the President of the company. Of those that do have a Board, many operate the Board as nothing more than an extension of the senior management team to make short-term operational decisions rather than long-term, strategically focused Corporate Governance.
We have been exploring how an ESOP can be a key component of your Business Succession Plan. Selling to an ESOP helps the business owner Maximize the After-Tax Proceeds, Providing the Greatest After-Tax Return while at the same time Increasing the Cash Flow of the Company by Eliminating the Company’s Ongoing Income Tax Obligation. In other words, the tax savings for Incorporating an ESOP in your Business Succession Plan will provide the funding for the sale of the company to the ESOP.
We have been discussing how the recent ESOP Economic Performance Survey (EPS) revealed that 93% of ESOP companies found that establishing an ESOP was “a good business decision that has helped the company.” While there are many reasons for this, one of the significant reasons is because S Corporation ESOP companies are not subject to income taxation (federal and most states), increasing cash flow and providing the company with a competitive advantage. Yes, you read that right, S CORPORATION ESOP COMPANIES ARE NOT SUBJECT TO INCOME TAXATION!
The results of the ESOP Economic Performance Survey (EPS) were released last week – 93% of ESOP companies found that establishing an ESOP was “a good business decision that has helped the company.” If a business owner is interested in preserving the long-term success of the company and its employees after he/she leaves or sells the company, this is a pretty strong indicator that an Employee Stock Ownership Plan (ESOP) would be an ideal way to accomplish that objective.