Q: What factors are favorable to creating an ESOP?
A: You’d like to see strong cash flow, a solid management succession plan and the capacity for more borrowing if necessary.
Q: Who are typically chosen as trustees?
A: There are a number of institutional trust companies that have a specialty acting as an ESOP trustee. At smaller companies, sometimes an insider other than the selling shareholder will act as the trustee.
Q: What do the employees own and what happens when they leave the company or retire?
A: They own a beneficial interest in shares of stock of the company, which means they receive all the economic benefits of ownership, such as appreciation in value and any dividends that are paid. But they don’t have the ability to sell those shares whenever they want. When they leave the company, the rules require that their stock be converted to cash by the ESOP, which would issue them a check, or they might receive the stock, in which case the company has an obligation to buy the stock and pay them cash.
Q: What changes have you seen when companies become employee-owned?
A: Often there is a significant cultural shift, and many ESOP companies work very creatively to generate that shift. What they are trying to get across to the employees is that now they have shared rewards as well as shared responsibilities, and they try to create a more collaborative, participative working environment where the employees feel empowered to make decisions that will improve the bottom line for everybody. I have seen studies that show employee-owned companies generally have higher productivity and operate more profitably than their peers.
Q: Do employees at an ESOP face additional taxes before they retire?
A: No. From the employee’s perspective the tax obligations on an ESOP benefit payment are the same as they are for a 401(k) participant. It is ordinary income unless you roll it into an IRA. There is a 10 percent penalty if you receive it before you are 59½ unless an exception applies. If an ESOP participant receives stock from the plan in a lump-sum distribution and the stock has gone up in value, that appreciation in value may be taxable as a capital gain.
Q: What are the highest payouts you’ve seen as people retired from these companies?
A: I have seen payouts greater than $2 million, and I have seen accounts of people who are still working that are even higher than that.