I began my career at what is now a publicly owned investment management firm that trades on the New York Stock Exchange. It was a typical large corporation with several hundred employees. It was a fine place to work, but most employees had no sense of ownership — no skin in the game. I then […]
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I began my career at what is now a publicly owned investment management firm that trades on the New York Stock Exchange. It was a typical large corporation with several hundred employees. It was a fine place to work, but most employees had no sense of ownership — no skin in the game. I then moved on to a firm that was client-owned. Again, no sense of employee ownership, but an entirely different ownership structure and culture. Today, I work at a firm with an employee stock ownership plan (ESOP). And it’s a firm from which I hope to retire.
An ESOP is a qualified defined-contribution employee-benefit plan designed to invest primarily in the stock of the sponsoring employer. In short, our employees become the owners of our firm, M. Griffith, through the ESOP. We have skin in the game with what I believe is an unmatched ownership structure and culture. Our employees have a sense of ownership, and you can see and feel that throughout the firm in attitudes, interactions, and responsibilities.
A surface-level understanding of employee ownership would likely begin with a thought of not wasting paper or turning off the lights to your office when you leave. Simple cost savings. I’ll admit, these were my first thoughts upon learning about our ESOP. The truth is that our ESOP provided more of a mental eye-opener once I really grasped the concept. I can see this same revelation occurring in my colleagues as well. The revelation is that we are now actual owners of our firm. Our ESOP enables us to directly share in the current and future economic rewards of ownership. The ESOP creates a direct link between employee productivity and employee benefits as it rewards employees for their efforts and they will automatically share in the growth of the company. Few ownership structures offer these advantages.
The great advantage of an ESOP is to provide a market for the shares of a departing owner of a profitable, closely held company. The owner can essentially “keep things intact” during the ownership transfer — whether immediate or gradual — and not worry about any outside manipulations. Unlike a sale or merger, an ESOP enables the selling business owner to sell any portion of his or her stock — allowing an owner to keep control until he or she is ready to fully retire. A sale or merger usually requires the owner to sell 100 percent control immediately.
There are other benefits available to both the selling owner and participants as well.
1. If the ESOP acquires 30 percent or more of the outstanding stock of a privately held company, any capital-gains tax on the transaction is deferred indefinitely, provided that the seller reinvests the proceeds in “qualified replacement property” within 12 months of the date of sale (for certain business structures).
2. The ESOP enables the company to repay principal with tax-deductible dollars (for a leveraged ESOP).
3. Dividends paid on stock held by an ESOP are fully tax-deductible, provided that such dividends are either passed through or used to make principal or interest payments on an ESOP loan.
4. An ESOP enables owners to provide for business continuity for the business that they have grown and nurtured over many years. Unlike a sale or merger, an ESOP enables a company to retain its separate identity rather than become a branch or division of a larger company.
5. An ESOP can be used to make acquisitions of other companies with tax-deductible dollars. In addition, the sellers can receive their proceeds tax-free under tax-code provisions.
Many ESOPs are used as a supplemental employee-benefit plan, which will typically be a better incentive plan for employees than other alternatives. This enables the company to attract, retain, and motivate key employees. An ESOP is designed to enable employees to benefit from the ownership of capital through the investment of their talent and energy. Several research studies have shown the numerous benefits of ESOPs for business owners and their employees, many of which are realized while the owner is still actively engaged in the business. Some include:
- A 2000 Rutgers study found that ESOP companies grow 2.3 percent to 2.4 percent faster after setting up their ESOP than would have been expected without it. Businesses that combine employee ownership with employee workplace-participation programs show even more substantial gains in performance.
- A 1997 Washington State study found that ESOP participants made 5 percent to 12 percent more in wages and had almost three times the retirement assets as did workers in comparable non-ESOP companies.
- A National Center for Employee Ownership (NCEO) study found post-ESOP sales were 4 percent per year higher, while employment growth was 3 percent per year higher.
- A return-on-assets study conducted by Northwestern University found that public ESOP companies generated an increase in this measure 2.7 percent per year better than what would have been expected based on pre-ESOP experience.
- Companies with ESOPs and other broad-based employee-ownership plans account for well over half of Fortune Magazine’s “100 Best Companies to Work for in America” list year after year.
- Many owners take advantage of the tax-deferral provisions under IRS code (any capital-gains tax on the transaction can be deferred indefinitely provided a few criteria are met).
- Contributions to ESOPs are tax-deductible to the sponsoring corporation up to certain limits.
These studies, and many more, show that sales, employment, and productivity all grow faster in companies after they set up their ESOPs than would have been expected based on their performance relative to comparable companies prior to setting up their plans. The research also shows that ESOPs are more likely to survive as independent companies which helps to prolong the mission and vision of the founding owner.
I have just touched the surface on the many benefits of creating an ESOP for a business. Numerous resources are available to learn more. What is unique is that both owners and employees alike reap the rewards associated with having an ESOP. As someone who has worked at firms with several ownership structures, I believe it is hard to beat an ESOP.
Matthew D. Savery, CFA, CFP is the chief investment officer at M. Griffith Investment Services, Inc. M. Griffith is celebrating its 70th anniversary this year and its 5th year having an ESOP. Contact Savery at
msavery@mgriffithinc.com