Implementing an ESOP is an Act of Generosity

I have spent a lot of time talking about the top benefits of implementing an ESOP for a company, the business owner(s), management and key employees, all employees, and the local community.  These benefits include the tax and cash flow benefits and the many competitive benefits of building an ESOP ownership culture.

ESOP Corporate Governance

I talk to a lot of business owners and management that are considering implementing an ESOP and their #1 concern is control. 

On one hand business owners appreciate the control premium that an ESOP can pay for a change in control. 

On the other hand, they are very concerned about the unknown about what a change in control means and doesn’t mean. 

Fast forward a few years and many business owners will tell you that moving to a more formal board with some outside board members was one of the top benefits of implementing an ESOP. 

It is important to understand the corporate governance and ESOP stakeholders, what is an ERISA fiduciary, and the relationship between the ESOP Trustee, Board of Directors, and the ESOP Committee. 

What is Corporate Governance?

Corporate governance is how corporations manage the business affairs of the company to achieve their corporate and shareholder objectives.  

Who are the Corporate Governance Stakeholders?

  • Shareholders– The shareholders are the owners of the company. The primary responsibility of shareholders is to elect the Board of Directors. 
  • Board of Directors– The Board of Directors are responsible for corporate governance and delegate authority to officers/management. The Board represents the Shareholders, is the highest level of management in a company, and is responsible for governing the company. The Board has a corporate fiduciary obligation under state law to the Shareholders. Advising the CEO and succession planning are other key responsibilities.
  • Officers/Management– The officers/management are appointed by the Board to carry out the strategic direction of the company and are responsible for the day-to-day operations of the company.  Management hires the employees for day-to-day operations and to carry out the operational plan.

Who are the ESOP Stakeholders?

  • ESOP Plan Sponsor– The employer that establishes and maintains the ESOP.
  • ESOP Plan Administrator– The individual(s) with authority and discretion over the management of the plan. Unless another individual or entity (e.g. ESOP Administrative Committee) is specifically assigned, the Plan Sponsor is the legal Plan Administrator and decisions are made by the Board of Directors. The Administrator(s) is an ERISA fiduciary.
  • ESOP Administrative Committee– The ESOP Administrative Committee is usually appointed by the Board of Directors and serves as the Plan Administrator.
  • ESOP Trustee- The ESOP assets, which primarily consist of the stock of the company, are held in a trust and managed by the ESOP Trustee. The ESOP Trustee is the individual(s) with authority and discretion over the plan assets. For most purposes the ESOP Trustee acts as the legal Shareholder of the ESOP.  The ESOP Trustee is an ERISA fiduciary and has a fiduciary duty to act in the sole interest of ESOP Participants, maximizing the long-term value of the assets of the trust (the stock of the company). The ESOP Trustee will often vote according to the direction of the ESOP Administrative Committee. In addition to ERISA, the ESOP Trustee is governed by the Internal Revenue Code, the plan document, and trust document.  
  • ESOP Participants– The ESOP Participants are beneficial owners of the company and generally have limited legal authority.  In most cases the ESOP participants as Shareholders are represented by the ESOP Trustee.  The plan document specifies the voting rules. Unless provided by the plan document, the ESOP Trustee is not required to pass-through decisions such as voting for the Board of Directors, buying or selling stock, and exercising voting rights. In limited cases, such as a significant corporate event (e.g. liquidation, sale of all or substantially all the assets, recapitalization, merger), the ESOP Participants may have the right to have pass-through voting rights on all issues, including the election of the Board.

Corporate Governance eBOOK

What is an ERISA Plan Fiduciary?

A plan fiduciary is a person that exercises discretionary authority or control over the management of the plan or plan assets. ERISA defines the four primary duties of an ERISA fiduciary: 

  • The Exclusive Benefit Rule – An ERISA fiduciary must act solely in the interest of the plan's participants and beneficiaries while defraying reasonable plan expenses.
  • The Prudent Person Standard – An ERISA fiduciary must act with the care, skill, prudence, and diligence under the circumstances that a prudent man acting in a similar capacity...
  • Diversification – An ERISA fiduciary must diversify the investments of the plan unless it is clearly prudent not to, knowing that by definition an ESOP is "Designed To Invest Primarily In Qualifying Employer Securities".  You should also be aware of the ESOP diversification rules.
  • Follow the Plan Documents – A fiduciary must act in accordance with the plan documents.


What is the Relationship
 between the ESOP Trustee, Board of Directors, and the ESOP Committee?

  • The ESOP Trustee is selected by the Board of Directors. 
  • The ESOP Trustee generally votes the ESOP shares for the election of the Board of Directors. The ESOP Trustee will often vote according to the direction of the ESOP Administrative Committee.
  • The ESOP Administrative Committee is usually selected by the Board of Directors and generally consists of members of management. 
  • This "circular" selection process often leaves the same people in charge of the company and the ESOP. 

Building a Sustainable Ownership Culture with ESOP Corporate Governance — Part 2

In part one of this two-part blog series, we dicsussed how shareholders, the Board of Directors, and the ESOP trustee all play a role in developing and maintaining an ownership culture. In this article, we'll take a look at the roles of officers/management, employees, and the Plan Administrator.

Building a Sustainable Ownership Culture with ESOP Corporate Governance — Part 1

Many ESOP companies strive to build and sustain a strong ownership culture that will increase shareholder value. Developing an ownership culture is an ongoing process that evolves over time.  A strong ownership culture can be driven by the CEO, sometimes referred to as the keeper of the culture, and the Board of Directors (“Board”) through corporate governance.  This two-part article series will review the various stakeholders in the corporate governance of an ESOP company, explore their roles in the process, and things stakeholders can implement to strengthen the culture.

Responsibilities of an ESOP Company Board of Directors

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. 

ESOP Company Board of Directors Responsibilities

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

ESOP Corporate Governance

Corporate governance is how corporations manage the business affairs of the company to achieve their corporate and shareholder objectives.

Board of Directors


The Board of Directors are part of the ESOP Corporate Governance process.

Shareholders and Ownership Culture

Earlier this week we took a look at the role that Shareholders have in the ESOP Corporate Governance process. A Closer Look at Business Education: Employee Ownership explores how the presence of an ESOP and the resulting employee ownership can structurally improve the culture. The emphasis on long-term company performance will increase as the influence of outside stakeholders decreases and employees and management more actively participate in the corporate governance process. This translates into more employee engagement and entrepreneurship:


On the uniqueness of employee-owned companies: There are at least two issues here; structure and culture. Structurally employee owned companies have fewer external constituencies, e.g. investors, shareholders engaged in the governance structure. Hence there is more of a long term focus on company performance and employee and management voice in governance. This difference in structure of course translates directly into culture where behavior is much more focused in broad based engagement of employees in driving innovation and customer interface. These employees are encouraged to behave entrepreneurially since they have a real sense of ownership and control of their futures, rather than waiting for someone else to innovate or make a decision. My sense is that corporate culture is part of the DNA of a company and is best embedded from the beginning. Corporate cultures are very difficult to change once bureaucratic structures become entrenched.

Shareholders

Shareholders are a participant in the ESOP Corporate Governance process.

Role

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