8 ESOP Myths Debunked

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When considering employee benefit and owner succession plan alternatives,business owners often overlook the possibility of an ESOP: an EmployeeStock Ownership Plan. In an ESOP, the company establishes a trust whichinvests primarily or completely in the stock of the company. Employees become vested in this stock, giving them an ownership and financial interestin the company. Upon leaving the plan, and based upon the ESOP document,employees receive the amount of stock and cash in which they are vested.The company then buys back the stock (resulting in cash for the employee), usually transferring the repurchased stock to a different pretax participantaccount. For a company owner or shareholder, an ESOP provides a good exitstrategy at retirement. Often, an ESOP may be the only market for a minorityshareholder in a closely held company.

Unfortunately, although ESOPs have significant benefits for employer andemployee alike, many business owners decide against them because theyhave fallen prey to one or more common ESOP myths and misconceptions:

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I don’t have the right type of company. The type of company is irrelevant when considering an ESOP. Both large and small, public and private companies can form ESOPs. S corporations as well as C corporations are eligible. What is important is that your company has a strong

cash flow, a history of increasing sales and profits, and a substantial interest in

providing employees with equity.

M Y T H 1

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An ESOP is expensive to set up andmaintain. Certainly ESOPs do have legal and administrative costs, but not excessively so.Setting up the ESOP may cost $50,000 to $100,000, with annual administrative and

appraisal expenses running perhaps a third of that amount. However, the benefits to

both employer and employee can easily make this a very worthwhile annual investment.

M Y T H 2

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My employees don’t have the moneyto buy the company stock. Although an ESOP is an Employee Stock Ownership Plan, the employees are not the ones purchasing the stock: the company makes corporate pretax contributions

to fund the ESOP, or the ESOP or the company can borrow money to buy company

stock. If employees wish to buy stock with their own funds, that can be arranged,

but it is a completely discretionary part of the setup of the ESOP, as it is higher risk

and more costly.

M Y T H 3

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My employees won’t have the security of diversification in their retirement accounts. Three factors counter this concern: first, companies usually have a 401(k) plan or

other type of retirement plan available in addition to the ESOP. Second, ESOPs are

not required to invest exclusively in company stock – they can also have investments

in cash and other securities. Third, by law, ESOP participants who are approaching

retirement age must be given an opportunity to diversify up to 50% of their ESOP

stock account.

M Y T H 4

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The company will have to make afixed contribution every year. A recurring contribution, yes. An annual contribution, no, unless there is a loan involved with the ESOP that needs to be repaid. In fact, in some instances, it may be

wise to make larger contributions to accumulate cash in the ESOP to counter years in

which cash flow may be in short supply.

M Y T H 5

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I will have to divulge complete financial data to my employees. There may be – and often are – distinct benefits to providing full financial information

to employee-owners, but this is not mandatory. Companies are only required to share statements documenting the total value of the account, vesting and stock value.

M Y T H 6

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I will lose control of my company. Remember that ownership does not equal control. While in non-public ESOP

companies voting rights on shares allocated to ESOP accounts must be “passed

through” to ESOP participants for votes on major corporate matters, other decisions

can be voted by a named fiduciary or as otherwise designated in the plan. Often,

this fiduciary is the selling shareholder of the stock, who takes that position after

the sale of the stock to the ESOP has been completed. Additionally, wise employees

recognize that decisions should be made by those individuals most qualified to make

them. In other words, establishing an ESOP does not imply moving to a completely

democratic business model; company leadership can and should remain intact.

M Y T H 7

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I will be stuck in it forever. If your company’s needs change, you can terminate the ESOP. At that point, all participants become 100 percent vested and distributions must begin as soon

as possible.

M Y T H 8

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SES ADVISORS has one of the nation’s largest core groups of ESOP professionals, with offices in Pennsylvania,New Jersey, New York, Massachusetts, Rhode Island, Vermont, Illinois, Indiana, Virginia and Texas.

HEADQUARTERS: 10 Shurs Lane, Suite 102, Philadelphia, PA 19127 | 215.508.1600

An ESOP is, without question, a valid employee benefit and owner successionplan alternative. It can also be much more than that, as it can be used to raisenew equity capital, refinance outstanding debt, and acquire productive assetsthrough third-party borrowing. By discarding the myths and misconceptionsthat surround ESOPs, you can accurately weigh the benefits of establishingan ESOP and make a strategic decision that will guide the growth and development of your company for years to come.

Find out if an ESOP is right for your company. Visit www.sesadvisors.com to learn more.

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