ESOPs translate to ownership for all
Over the next decade an estimated 4.5 million businesses will change hands across Pennsylvania.
But roughly 70 percent of business owners 55 or older don’t have a business succession plan in place, according to PaCEO, a nonprofit dedicated to supporting employee business ownership.
A few do: About 300 Pennsylvania companies are operating under employee stock ownership plans, or ESOPs, which means they have a perpetual succession plan in place, according to Michael Wolfe, a partner at Trout Ebersole & Groff, LLP in Lancaster.
An ESOP works like a retirement plan, but one relying on company stock instead of, say, mutual funds. Once employees reach retirement age, they can “cash out” of the business by selling their stock back to it.
Employees can receive shares in a number of ways: From annual compensation including wages, bonuses or pay increases, or they can be made available when certain employment criteria are met, much like becoming vested in a profit sharing or other benefit plan.
“ESOPs work because it gives everyone a sense of ownership and they reap the value of their hard work,” Wolfe said.
What’s more, tax benefits to the company as well as employees may make an ESOP an attractive succession plan.
Employees with shares in an ESOP are not taxed on the value of those shares until they take the proceeds.
Business owners offering an ESOP can take advantage of tax-deferred gains from the sale of the business, which can happen over time, or all at once, according to the Journal of Accountancy.
“The disadvantage is that it can be expensive to start up,” Wolfe said.
A feasibility study of the company’s financials is required and third-party company valuations are also required annually. Both the U.S. Department of Labor and the Internal Revenue Service share governance and regulate ESOP programs.
Wolfe doesn’t recommend an ESOP to firms with fewer than 25 employees.
Still, for owners looking to eventually exit the company or sell a portion of their stock, an ESOP provides several options.
“Some or all of the ownership can be sold … if there are multiple owners and not all want to sell, there is flexibility as well,” said Ryan Hurst, a manager in RKL LLP’s business consulting services group in Wyomissing, Berks County.
Business owners with an employee-first mindset, meanwhile, have the satisfaction of knowing the firm they started, and the employees that helped them along the way, are taken care of after the owner retires or exits the company.
“Many ESOP companies attribute their best ideas to their employees and believe that they are a by-product of the employee ownership culture,” Hurst said.