Although they have diminished greatly since the government closed the tax loop hole that had led to widespread abuse, Employee Stock Ownership Plans (ESOPs) are still an exit option for some companies.
The Wall Street Journal profiles a small business that wanted to pursue this option, but got sticker shock when looking at the cost of setting one up:
Mr. Nikolich was ready to start easing out of Tech Image, the technology public-relations firm he had founded nearly 15 years earlier. He didn’t want to sell to a much larger PR company, however, because he was concerned the new owner would slash his work force. And he wanted to stay involved in the business….
Given those criteria, employee ownership felt like the right path…. But he quickly learned that the cost of setting up an employee stock-ownership plan could top $100,000 — more than his 17-person company could handle.
Because of the abuse of ESOPs in the past, the regulatory hurdles have become quite high for small companies. Too bad, as many more small businesses might pursue this option for their employees if it was economically feasible.
I have found that many employees like the ability to get stock in the company they work for through an Employee Stock Ownership Plan because in an ESOP the stock is GIVEN to them rather than having to purchase it. While ESOP installations are relatively expensive compared to other plans, they can be significantly less costly than the $100,00 quoted in the article (less than half actually), if the owner is willing to do some research on his/her own to find a niche consulting firm — one that specializes 100% in ESOPs; the costs are generally offset by income tax savings to the company.
Actually, it is not true that ESOPs have been greatly diminished — in fact, their numbers (especially in terms of assets and participants) have grown substantially in recent years. There are now about 9,750 plans with $925 billion in assets and 11.2 million employees, 95% of which are in closely held companies, and most of these are in companies with fewer than 100 employees.
The rule change in 2001 just prevented very abusive applications of ESOPs; virtually no legitimate ESOP would have any conflict with them. The ESOP community actively promoted the changes once these abuses became promoted by unethical practitioners.
As to costs, ESOPs generally run $40,000 to $80,000 in the first year, plus about $15,000 a year for smaller companies (more as you get bigger) after that. That is high compared to other benefit plans, but vastly less than the cost of selling to someone else, which usually involves substantial legal fees, accounting fees, and a percentage of the transaction for the broker (often 5% to 10%).
Costs and complexity really should not be the major factors in choosing an ESOP, except for businesses that are very small (under 10 or 15 employees). Capable transition management, reliable profits, and a willingness to create a true ownership culture with employees are more important.
Details on tax benefits of ESOPs and other issues can be found on the web site our nonprofit information organization, the National Center for Employee Ownership, at http://www.nceo.org.
Thanks for the information!