ESOP Benefits

ESOPs provide the obvious benefit of providing an exit strategy to an owner, but also benefit employee retirement plans just as much.

When an owner sells the business to the employees, the retirement benefits that accrue through being a part of an ESOP are protected under the Employee Retirement Security Act of 1974 (ERISA), just like a 401k or a pension plan.

“It provides a substantial amount of dollars toward employee’s retirement. So it’s great for retaining employees and attracting new employees because of that retirement benefit ESOPs provide,” said Denny Mann, president of service at Marina Mechanical in San Leandro, California

When Michael O’Connor, president of Alltek Energy Systems in Waterford, New York, was owner of Alltek, it operated as a C-corp and over the years had been averaging about $300,000-$500,000 a year in corporate taxes. But after implementing an ESOP, the classification of the company became more like an S-corp.

“Ultimately after a few years, the company itself become tax exempt,” O’Connor said.

An ESOP ended up being a good way to help Alltek offset the cost involved in paying O’Connor.

ESOPs also help employee retention and employee performance, since a company’s share value goes up over time based on a company’s performance. So it creates a culture where everyone has a vested stake in how well the company does.

“It encourages financial performance or contribution from everyone's level, because we all gotta roll in the same direction or we're all paying the price,” said Ken Misiewicz, president and CEO of Pleune Service Company in Grand Rapids, Michigan. “There’s a saying: ‘When you’re family, there is no such thing as your end of the boat.’ And that’s exactly what an ESOP is … It really motivates people differently.”

Larry Davies, former owner (now on the board of directors) of All Comfort Services in Madison, said ESOPs provide an opportunity for what owners and their employees created to continue on.

“If they carry on the tradition and the quality of service that we've provided over many decades, the legacy will hopefully go on another 50 years,” Davies said.

Overcoming Challenges of ESOP

Not only do owners have to understand the process from start to finish and establish operating conditions, but so do the employees — and they have to buy into it. This can be a hard message to communicate.

Misiewicz said it’s important, when a seller is thinking of creating an ESOP to sell to their employees, to not only get legal counsel specifically from someone with extensive experience in the ESOP space, but also get counsel from someone who has lived in the ESOP world.

“Because lawyers will give you answers to any questions you ask. And they are brilliant, but they don’t run companies,” Misiewicz said.

Since ESOPs can be written any way the company wants as long as it’s within the guidelines of ERISA, just like a pension plan or 401k, that advisor whose lived in the ESOP world (in addition to legal and accounting counsel) is critical. There’s a myriad of options and things to consider and work through.

“However you create your plan, you want to get it as right as possible the first time because if your messaging is wrong, it’s very disruptive,” Misiewicz said.

O’Connor found it very hard in the beginning to understand the process from start to finish and how he was to operate being part of an ESOP. It was also difficult to get his employees to understand the underlying benefit they get as a participant of an ESOP: What happens when they retire or leave the company.

“If you stay with the company for 10, 15, 20 years and decide to retire or change your career … whatever you do, you’ll end up leaving with this huge benefit of having a company buy your shares back, which equates to major dollars,” O’Connor said.

This could be anywhere from hundreds of thousands to millions of dollars, depending on the company.

Through annual meetings with Alltek employee shareholders, accountants, trustee, and ESOP attorneys and advisors, O’Connor tries to get the real message out: “Every employee is a shareholder. And if you stand by and watch other people perform not at the level you’re performing and you let that go, that’s money coming out of your pocket. So it motivates employees to work together and communicate better … it’s kind of a mental transition they make into almost working for themselves, in a way.”

Mann said Marina Mechanical sends out reminders of the benefits of ESOP to everyone in the company.

“The more profitable we are, the more of a benefit it is to them because more dollars are put into the ESOP. And then we annually hand out an ESOP certificate so they can see what the value of their retirement is,” Mann said.

Is an ESOP for You?

Having a retirement exit strategy might be as good a reason as any for an owner to decide an ESOP is the right fit. When it’s their time to retire, they can do so simply by selling their shares of the company. It’s especially convenient when a founder or owner is interested in succession and wants to transfer it to the employees, but they need a little help financially to get there. But ultimately, deciding on an ESOP is a personal decision.

“The structure really fits in with an ownership when the culture is right — when the owner or leader of the group really want to take care of the people who got them there, but they need help with getting the right entity or structure in place to help them execute that financially,” Misiewicz said.

Mann said the timing needs to be right: There should already be some key employees in place who have been running the business.

“In other cases, the owner might be the only person running everything and then an ESOP would be more of a challenge,” Mann said.

O’Connor started the process of implementing an ESOP in 2015. At that point, it’d been on his mind for probably 10 years. After researching how an ESOP works, he felt an obligation to his employees that had helped him build the company.

Davies recently sold 100% of his stock in the company to his employees. Davies and his wife started the business in the basement of their home, and to some degree, they’ve built a legacy in Madison. And he wanted it to continue. Davies has employees who have worked for him for 40 years and so he ultimately decided it was a good way to extend the legacy, keep the business intact, and reward the employees who have helped build the business over the last 50 years.

“If you’re looking to maximize the sales price, then ESOP is not the way to go because you’re not going to get top dollar for it. But if you’re looking to keep everything intact and reward your employees, then you should look at an ESOP,” Davies said.