ESOP’s Have Vulnerabilities Insure Against Them
ESOP’s are popular. In the U.S.there are approximately 11,500 ESOP’s, covering about 10 million employees (about 10% of the workforce).
An ESOP is an employee-owned company that offers a flexible, tax-favorable way for owners to exit the business, and provides strong retirement benefits for the employee-owners.
All of us at Global Investment Strategies work closely with many owners and ESOP companies. Doug McClure, CEO of GIS, cited several reasons why ESOP’s are so popular.
- An ESOP creates an immediate market for the owner’s stock, and a buyer for the owner’s business.
- An ESOP locks in stock value, eliminating future valuation reductions due to ever changing business and regulatory factors.
- Owners can transition the business to the employees over time if desired.
- An ESOP is a business continuation strategy, keeping the brand name developed over years alive and well.
- ESOP tax advantages can greatly increase operational cash flow.
- For the family business, an ESOP can be an excellent tax beneficial succession planning tool to the next generation and key employees.
- Employees are active investors. Each employee works to increase the value of their company. When that value grows, the employee’s retirement funds grow.
- As a defined benefit program, an ESOP is a very attractive tool in recruiting and retaining high level talent.
However, within this versatile and advantageous structure are vulnerabilities. To guard against these pitfalls, Doug emphasizes the importance of a well planned life insurance strategy. Specifically:
An ESOP is a retirement plan for employees, and they will eventually retire (or depart, or unexpectedly die). Life insurance solves this problem, accumulating needed funds to meet stock repurchase retirement liabilities.
An ESOP in essence is a large buy-sell arrangement with employees. If founders own a high percentage of stock, a separate buy-sell policy protects the company in the event of an unexpected death or departure.
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