Advantages of Employee Ownership

Invest in Your Employees
and Your Business with an ESOP

As of 2022, the National Center for Employee Ownership (NCEO) estimates roughly 6,500 ESOPs covering almost 14 million participants.An ESOP is an attractive employee benefit and corporate financing tool; its structure can range from simple to very complex. Its feasibility should be considered by competent lawyers, accountants, and administrators to ensure tax deductibility compliance with the Internal Revenue Service regulations and to meet the employee benefit plan requirements of the Department of Labor.

Benefit to Employees

An ESOP can provide an employee with significant retirement assets if the employee is employed by the company for a significant period of time and the employer stock has appreciated over the years to retirement. The ESOP is generally designed to benefit employees who remain with the employer the longest and contribute most to the employer’s success. Since stock is allocated to each employee’s account based on a contribution by the company, the employee bears no cost for this benefit.

Employees are not taxed on amounts contributed by the employer to the ESOP, or income earned in that account, until they actually receive distributions. Even then, “rollovers” into an IRA or special averaging methods involved in the income calculation can reduce or defer the income tax consequences of distribution.

When the employee’s participation in the ESOP ends, they are entitled to their share of the “vested” benefit according to a schedule incorporated into the ESOP document. Distributions may be made in stock or cash. However, a “put” option, which requires the Plan or the company to acquire stock distributed to participants, may provide cash for their shares. This is especially valuable to participants in privately held companies where there is no market for the company stock.

Benefit to Employers

An ESOP invests contributions primarily into employer stock and uniquely allows employees to borrow funds on employer credit to acquire said stock. These distinctions provide significant flexibility for companies utilizing ESOPs in their corporate finance strategies, enabling the achievement of objectives unattainable through alternative methods.

Functioning as a corporate finance technique, an ESOP can be used to raise new equity for debt refinancing or asset acquisition through leveraging with third-party lenders. Since contributions to an ESOP are fully tax-deductible, employers can utilize pre-tax funds to cover principal and interest payments on the ESOP's debt obligations. Additionally, dividends used for loan repayment may also qualify for deduction.

An equally significant advantage for both employer and shareholder lies in the positive outcomes stemming from employee ownership in the form of equity. This ownership fosters enhanced productivity, profitability, and overall corporate performance.

Benefit to Shareholders

An ESOP can create a market for the stock of a privately held company. The ESOP provides a ready, current market for the stock of outside shareholders providing liquidity not otherwise available. This feature may be used by participants, beneficiaries, major shareholders or estates of deceased shareholders.

The ESOP leveraging provides a way for a selling shareholder to receive cash, rather than incur the risk of a deferred payment arrangement.

Subject to certain conditions and regulations, the Code makes provision for special tax incentives for certain sales of stock to an ESOP. This would enable a shareholder of a closely held company to sell stock to an ESOP, reinvest the proceeds in other qualified securities and defer taxation on any gain resulting from the sale.

Benefits an an ESOP

Employees remain a business’s most important asset. An ESOP involves selling a business to a retirement trust that ultimately benefits the employees. It provides economic value to the owner and significant tax and cultural advantages that would otherwise not be realized in a third-party sale.

These include:

Cash Flow: ESOP-owned companies produce more free cash flows and default less than their peers
Community: The business is more likely to stay locally owned and benefit the community
Flexibility: ESOP transactions permit the owner to sell all or part of the business and, if desired, remain involved
Job Retention: ESOP-owned companies are less likely to partake in layoffs, even during recessions
Legacy: The company name is less likely to change
Reward: An ESOP delivers exceptional benefits to loyal employees
Tax-Efficiency: Numerous tax benefits can make an ESOP transaction economically valuable to the owner and employees

Several studies conclude employee ownership enhances productivity, increases profitability, and improves employees’ commitment and sense of ownership. ESOP advocates maintain that the main variable in securing these claimed benefits is to combine an ESOP with a substantial degree of employee involvement in work-level decisions.

Other Advantages

The benefits of an ESOP go beyond monetary gains. Employee ownership can significantly impact workplace culture. ESOPs frequently foster robust employee engagement and cultivate a sense of shared responsibility among staff. Employees typically gain deeper insights into the factors driving company profitability, leading them to become more proactive in improving efficiency, managing costs, and encouraging innovation within their respective industries.

This ethos is often termed ownership culture or ownership thinking by employers. When employees feel like owners, they naturally become more invested in the well-being and health of the business.