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A primer on Employee Stock Ownership Plans (ESOPs)

November 4th, 2020 / By: / Expo News

An Employee Stock Ownership Plan (ESOP) offers lots of attractive benefits: studies have shown that ESOPs improve productivity, increase sales and improve return on assets, plus they offer great tax advantages.

But more than any of these attributes, an ESOP offers the owner of a company peace of mind and an enduring legacy.

“Many times, selling owners care tremendously about what happens to the company and employees after a sale,” said Chris Fredericks, president of Carmel, Ind.-based textile supplier TVF. “In some cases, financial buyers or [strategic buyers] may have an interest in taking actions that will financially benefit themselves over the long term, but may not actually be in the best interest of the current employees of the business. That’s really where an ESOP can provide a lot of peace of mind to a selling owner and should be highlighted as one of the most important reasons to consider an ESOP.”

Fredericks was chief financial officer with TVF in 2010, when the company’s founder, Dick Hanzel, began to consider what he would do with the business when he retired. The company’s accounting firm recommended an ESOP, and Fredericks led the process that resulted in TVF becoming an employee-owned company. As a part of IFAI Virtual Expo 2020, Fredericks shared his knowledge about the process in an educational session for business owners.

“Think of it like a 401(k) plan that buys the shares of the company,” Fredericks says. “Those shares are held in a trust, and that trust is set up to be for the benefit of the employees of the company. Those shares that are sold to the trust and held in the trust end up being allocated out and shared with the employees over time. That’s essentially the employee benefit element of it.”

Fredericks outlined attributes of companies that are good candidates for an ESOP: they have a proven history of success, more than 20 employees, at least $5 million in revenue and $500,000 in profit, and stable leadership that will continue after the owner has retired.

“It’s usually not going to fit if the business is built around the owner in a way that, once the owner retires, much of the value and the relationships of the business leave with the owner,” he said. Turnarounds or struggling companies are also not good candidates, nor are companies whose owners only goal is to maximize purchase price, although ESOPs are required to pay full market value.

Fredericks offered a simplified overview of how an owner can sell to an ESOP, emphasizing that the key is to work with advisors who frequently do ESOP transactions.

“The right advisors can really help you figure out what’s best for you,” he said.

Registration for IFAI Virtual Expo 2020 is open through Nov. 12. All Expo sessions will be posted on the Virtual Expo platform for viewing during Expo and for 30 days after Expo has concluded.