A treasure trove of baby boomer assets are buried in business ownership. LIMRA estimates pre-retirees have $4.8 trillion of net worth tied to the value of the businesses they own. One key to unlocking those assets is an employee stock ownership plan (ESOP). ESOPs can help business owners diversify their portfolios and plan for their eventual business exit. ESOPs also represent a significant untapped opportunity for financial professionals who would be in the position to help business owners invest the assets as well as get access to risk protection products.
An ESOP is a qualified defined contribution retirement plan that invests primarily in the stock of the sponsoring corporation. ESOPs are unique in that they can borrow money to purchase the stock from the selling shareholders. ESOPs are useful in helping business owners diversify their portfolio, plan for ownership succession of the organization and help their employees prepare for retirement.
While ESOPs have been around since the passage of ERISA in 1974, there are a number of misconceptions that may prevent business owners from considering them. By addressing these misconceptions, you can help clients evaluate whether an ESOP is right for them based on their personal financial goals and their objectives for the company and employees.
1. The owner will lose control of the company. An ESOP doesn't change the company's corporate governance. The board of directors appoints the ESOP trustee, which can be an internal or independent person or group. The ESOP trustee is the legal shareholder and votes the shares on behalf of the retirement plan participants. The board and management remain in control of the company, even when the ESOP owns a majority of the company.
2. The owner will have to sell all of the company. An employee stock ownership plan allows the owner to decide how much of the business to sell and the time line for ownership transition. Often times, the owner will initially sell a minority interest (such as 30%), then complete a second-stage transaction at a later date. This is completely at the discretion of the business owner.
3. The company will have to disclose detailed financial information to the employees. As a qualified retirement plan, ESOPs must provide participants an annual statement illustrating the value and number of shares held for their benefit. There are no other financial disclosures required. Some companies elect to share greater amounts of information to engage employees, but it is entirely up to the company to decide.
4. The transaction costs of an ESOP are too large. ESOP transaction costs are very similar to the costs that would be incurred by selling to an outside party or to a family member. Regardless of how a business owner transitions ownership, accountants, attorneys and valuation companies are typically hired to make sure the transaction is completed at fair market value and that the sale is in good order.
As with other types of expenses, a competitive bidding process may help reduce the out-of-pocket costs to the business.
