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ESOPs: Align Employee Interests With Long-Term Business Goals and Succession Planning

Jun 19, 2017

More and more companies are struggling to attract and retain good employees. Today’s younger generations are not committed to or even looking for a lifelong career, and it is getting harder to find and keep good people. The workforce is changing, and in order to stay competitive, business owners are going to have to offer more benefits and flexibility than ever before.

On the flip side, many closely held companies do not have a plan for business continuity after the departure of a founder or majority shareholder. With the slated numbers of baby boomers expected to retire daily in the next two decades, companies who have not planned for these exits will struggle to remain competitive.

Wouldn’t it be great if there were a way to enhance employee loyalty and commitment to your bank and provide a market for the equity of a retiring owner, all while providing employees with an ownership stake and also raising capital for your bank? An Employee Stock Ownership Plan (ESOP) may be just the vehicle you are looking for.

ESOP Basics

An ESOP is a qualified retirement plan mandated to invest primarily in employer securities (bank or bank holding company shares) with the greatest voting power, dividend, and liquidation rights. The bank contributes stock or cash to the plan, which is allocated to employee accounts. The employees are not stock owners; the stock is owned by a trust, and the Trustees are the legal owners of the stock. While there are instances, such as a merger, reorganization, or a sale of a significant portion of company assets, that can require a participant to be given the right to have a say regarding the shares allocated to their account, in most instances, ESOP shares are voted by the Trustees. The employee benefit is tied to long-term stock performance, and since earnings and appreciation on stock held by an ESOP are tax-exempt, growth is on a tax-deferred basis.

ESOPs are frequently used in conjunction with an existing benefit plan, such as a 401(k) plan, and are the only qualified retirement plan that can be leveraged (i.e., may borrow funds to purchase Company stock). This permits an ESOP to “currently” purchase a block of Company stock that will be paid for and allocated to participant accounts over a number of years. A leveraged ESOP is often used to enable the ESOP to acquire a block of stock from a selling shareholder as part of the selling shareholder's succession planning or liquidity strategy.

A non-leveraged ESOP purchases Company stock using existing retirement plan assets or the bank contributes cash to the ESOP. No funds are borrowed to purchase stock.

ESOP Rewards

  • Motivates employees to be loyal, long-term team members by providing a benefit where they have an ownership stake in the bank.
  • Maintains or facilitates capital growth funded with tax deductible dollars.
  • Provides the sponsoring bank with stock and/or cash contributions that are tax deductible.
  • Creates a market for closely held stock, providing an additional source of liquidity for investors while maintaining control.
  • Provides substantial tax and financial advantages for all parties―tax deductible dollars are used by the bank to fund the plan, and employee accounts are tax-deferred.
  • Provides for a tax-deferred rollover option for an owner of a closely held bank to sell his or her stock.
  • Allow S corporations to receive additional tax benefits in that neither the bank nor the ESOP pays any income taxes on the bank’s income allocated to ESOP shares.

ESOP Hitches and Costs

  • Entity must be a corporation or taxed as one.
  • ESOPs are regulated by the Department of Labor (DOL) and the IRS and must comply with ERISA (Employee Retirement Income Security Act).
  • ESOPS are subject to minimum coverage and nondiscrimination rules.
  • Closely held banks must have their stock valued by a qualified, independent appraiser before shares are put into the ESOP.
  • The sponsoring corporation has a repurchase obligation that will require cash flow distributions upon employee retirement, death, disability, or other termination of employment.
  • ESOPs can cause dilution of stockholders’ equity interest in the corporation.

ESOPs should be carefully considered and tailored to best suit a company’s needs and goals. This requires a team effort that includes collaboration of the bank’s management, stockholders, accountants, and attorneys. While the process of setting up an ESOP can seem complicated, the benefits can far outweigh the costs and have been linked to increased employee production and work effort, dedication to the employer, and overall improved attitude toward the employer, which can translate into bottom line improvements.


Nicole L. Stewart, CPA
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