5 Reasons to Avoid an Employee Stock Ownership Plan

As mentioned in my November post, an employee stock ownership plan (ESOP) is an employee benefit plan that serves as a tax-qualified, defined-contribution retirement plan and presents some excellent cultural and financial opportunities. That being said, it’s not a great fit for every organization. There are a number of reasons why your company may want to pass on this strategy – for the purposes of this blog post, I’ll keep that number to five:

1. Heritage

If yours is a family-owned business, you may wish to keep it that way. No matter what benefits an ESOP may bring, it may still be the wrong choice for owners who wish to leave the company in the hands of their family’s next generation.

2. Foreign Workforce

Does your company have a large percentage of nondomestic workers? If it does, this factor could increase the complexity of an ESOP conversion, which of course would drive up the implementation timeline and the overall cost.

3. Poor Corporate Culture

Although an ESOP could improve corporate culture, it’s not exactly a silver bullet. In cases where a company’s culture is notably poor, it may actually be more likely to flop. If your culture is in crisis mode, you may want to consider investing in a solution for that before tackling the separate issue of ownership structure. Addressing these issues first will also inevitably allow you to realize a higher value for your company at a later date when an ESOP implementation would be more appealing.

4. Affordability (for Employees)

If your work force to company value ratio is far from balanced, it may be impossible to create a successful ESOP program. There are legislative limits on ESOP loan repayments as they relate to a company's total payroll. As such, a high value company that has a relatively low total payroll may be limited in its ability to implement an ESOP.

5. Cost to Implement

Conversion to an ESOP can be expensive. A midsized company could expect to spend tens of thousands of dollars on such a project, and this cost can sometimes extend to $150,000 or more. At that point, the tax benefits may have much less appeal. For smaller companies, the cost associated with even the most straightforward ESOP implementation could become a flat-out barrier to entry.  

To ESOP, or not to ESOP?

Many factors beyond what I have covered here can tip the scale for your company. For instance, if business owners are mainly concerned with the price of the sale, you may be fortunate enough to discover a buyer, even in this economy, who is willing to pay more than an employee ownership strategy would provide. Choosing an ESOP is a huge decision, and your company’s unique circumstances will ultimately determine which way to go. If you would like some assistance weighing the pros and cons, I am always here to help.

Follow this link to read my November post: 5 Reasons to Implement an Employee Stock Ownership Plan.

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Recent Comments:

Corey Rosen, National Center for Employee Ownership
December 19, 2011 - 2:02:00 PM

"These are good observations. Just to clarify on the affordability issue, the employer makes these contributions, not the employee. Also, if the payroll limit is a problem, companies can use dividends or distributions on top of the 25% limit or extend the ESOP loan (which is almost always structured as a loan from the lender to the company and a reloan from the company to the ESOP, often on different terms) for additional years. There are still some cases where payroll is too small, however.A more pressing issue is whether the company has the extra cash to fund what is a non-productive expense. ESOPs do not magically create more money.For more details on ESOPs and good reasons to do a plan or not, go to the article Twelve Bogus Reasons Not to Do an ESOP (and Seven Good Ones) at http://www.nceo.org/main/article.php/id/17/ "