Thinking about retirement? For those who own a company and are looking to hand control over to their employees, an employee stock ownership plan, or ESOP, might be an attractive option, but it doesn’t come without risks. The North Bay Business Journal interviewed Jim Andersen and Claudia Stern to get their take on this strategy.
ESOPs allow a company to set up a trust fund to which employees can contribute cash to purchase company stock, contribute shares directly, or have the plan borrow money in order to purchase shares in the company. If the plan borrows money, the company contributes to it to enable it to repay the loan.
A central benefit of ESOPs are that the contributions are not taxed until employees receive their stock when they leave or retire, and owners can sell out of a business over time.
But the plans do carry risk, particularly for owners who risk losing control of their company as they gradually offload shares to employees. It is also possible a business would not generate enough cash to buy out the owner. Employees also see risk, since if a business goes belly up, their retirement savings potentially do, too, with an ESOP.
How can ESOPs be used in business succession planning when an owner is looking to leave a business?
Claudia Stern and Jim Andersen: If an owner decides that the business should be transferred to the employees, this is a tax-efficient mechanism for getting the business to buy out the owner and for the employees to take control.
What are the potential risks of using an ESOP and providing employees with ownership interests in a company?
Stern and Andersen: From the owner’s point of view, the risk is the business will not generate enough cash to buy-out the owner. If the owner is handing over control or selling more than 50 percent of the ownership, the owner may not be able to prevent management from taking on risks or otherwise running the business in a way the current owner doesn’t like.
From the employee’s point of view, the company will be putting retirement contributions into company stock which increases an employee’s financial risk. If the company fails, not only will the employee lose their job but their retirement savings will be worthless.