They can be complicated. And they must be designed to meet strict tax
laws. But Employee Stock Ownership Plans (ESOPs) are growing each year
and there is evidence that companies with established ESOPs are seeing a
rise in productivity — and as a result, in sales and profits.
ESOPs are not a new phenomena. Since 1974, Congress has enacted dozens
of laws designed to encourage companies to provide stock ownership to
employees. The National Center for Employee Ownership estimates that
more than 11,000 ESOPs are in place throughout the country, covering
more than 10 million American workers.
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Though many employees covered by an ESOP work at publicly traded
companies such as United Airlines, Procter & Gamble and Publix
Supermarkets, by far the greatest number of ESOP companies are privately
owned, said Robert W. Edwards, a partner in the business law department
at Peabody & Brown in Providence.
Edwards is convinced that ESOPs are good for business, particularly
among those companies that also incorporate “participatory management”
practices. In fact, said Edwards, recent studies have shown that ESOP
companies have grown at a rate 3 to 4 percent faster than non-ESOP
companies.
“The fact is, the combination of employee ownership and a participative
management style brings increased productivity which, in turn,
translates into a competitive advantage for the ESOP company,” he said.
Edwards said that there is no “cookie-cutter” formula for “participatory
management.” But among practices that would be part of such an approach
would be delegating decision-making responsibilities and sharing
information critical to a company’s operations.
“That’s what it takes to get real productivity,” Edwards said.
Besides making sound business sense, Edwards sees ESOPs as making sound
social sense.
“If you have a society with a small number of haves, and a bunch of
people who perceive themselves as have-nots, you’re going to have
problems with the Democratic principals,” Edwards said. “By making a
significant number of workers capitalists, the social policy that ESOPs
further is hard to beat.”
For Andrew Craig, establishing an ESOP made perfect sense. Craig owns
Eagle Lumber, Inc., in Warwick, but works out of Dallas, Texas, where he
also operates a trucking company. Eagle Lumber became an ESOP at the end
of last year.
“The marriage of capital and labor is well accomplished through an
ESOP,” said Craig. “I just think it is a brilliant structure for
resolving the capital, labor division.”
Eagle Lumber is an interesting example. To hear Craig describe the
company, it makes perfect sense that the employees there, headed by
general manager Dave Hindle, would merit ownership in the company.
“I’m 1,500 miles away and I talk to them every day,” Craig said. “If
those guys in Rhode Island aren’t the most honest, hard working people
They run the shop. If anyone is deserving to be vested in ownership —
they are.”
The following are some common questions about ESOPs, as prepared by
Peabody & Brown and the Atlantic Management Company:
What is an ESOP?
Employee Stock Ownership Plans (ESOPs) are unlike other employee benefit
plans which typically diversify their holdings by investing in a variety
of assets. An ESOP is a retirement plan that is designed to provide
employees with an ownership interest in the company for which they work
by investing primarily in stock of the employer corporation. The ESOP is
funded with tax deductible contributions by the employer, which can be
in the form of company stock or in cash which is used to purchase
company stock. An ESOP operates through a trust, under the direction of
a plan fiduciary.
How does the ESOP benefit the company?
An ESOP is a technique of corporate finance as well as an employee
benefit plan. An ESOP can be used to raise new equity capital, to
refinance outstanding debt, or to acquire productive assets through
borrowing from third-party lenders. ESOPs can be used to increase cash
flow by making plan contributions in stock instead of cash.
Since contributions to the ESOP are fully tax deductible, an employer
can fund both the principal and the interest payments on an ESOP’s debt
service with pre-tax dollars.
Dividends on ESOP stock are tax deductible if they are applied to repay
ESOP loan principal. Reducing loan principal with pre-tax contributions
and dividends generates significant tax savings, which in turn increases
the ESOP company’s cash flow.
Can existing 401(k) remain in place if an ESOP is set up?
Yes. In fact, the company can use stock instead of cash to match the
employee contributions to the 401(k) plan. This technique will increase
the company’s cash flow.
Can an existing profit sharing or defined benefit plan remain in place
if an ESOP is set up?
Yes, but the amount of contributions to other plans is usually reduced.
What is a leveraged ESOP?
An ESOP is leveraged if it borrows money to purchase shares of the
employer’s stock. The loan may be from a bank or financial institution,
or the selling shareholder may finance the transaction by taking back a
note for all or part of the purchase price.
Aren’t ESOPs very expensive to set up and administer?
Costs are a function of the complexity of the transaction. If owners
take the time to get a better understanding of ESOPs, initial costs can
be reduced.
Do all company employees have to participate in the ESOP?
No. However, in order to satisfy IRS guidelines, the ESOP must cover a
substantial percentage of non-highly compensated employees who have
attained age 21 and have completed a year of service. For this reason,
ESOPs established by smaller companies usually cover all employees who
have satisfied these minimum age and service requirements.
Once an ESOP is set up, am I stuck forever?
No. Just as a company can terminate a profit sharing plan, it can also
terminate an ESOP. At that point, all participants must become 100
percent vested.
