Understanding ESOPs, part 1

Having the ability to offer candidates participation in the ESOP may provide your company a benefit your competition cannot offer.

Back in September, we were honored to be a sponsor and presenter at Zweig Group’s Hot Firm + A/E Industry Awards Conference in Dallas. From our conversations with attendees, and from discussions that took place in break-out sessions, we heard about the “talent crisis,” a firm’s “community,” and the need to “combat commoditization.” Firms in the AEC space continue to look for ways to differentiate themselves, while faced with a macro-environment that is making it hard to continue to grow and expand.

A recent release from Zweig Group, the 2018 Principals, Partners & Owners Survey, noted that less than 50 percent of the companies surveyed had a succession plan in place. This article, and the ones that will follow it, will be dedicated to employee stock ownership plans as a succession plan alternative. Selling all or a portion of a company to an ESOP has many pros and cons, and here, we will focus on the non-quantifiable benefits ESOP-owned companies enjoy.

  • Culture. Often referred to as the “secret sauce” of any company, a company’s culture is also one of the most fragile components of its DNA. What takes years to build can quickly change if not embraced and properly managed. Firms in the AEC industry often share a similar ownership culture as many ESOP-owned firms, with ownership held by many within the organization. This broad ownership provides not only economic benefits to shareholders, but responsibility, accountability, and professional gratification that may not exist for non-owners.
    However, private ownership held by a group of management may lead to a “haves versus have-nots” scenario, creating an unintentional and unnecessary distraction. Additionally, as firms continue to grow, the economics behind buying ownership may be too great for key individuals, making it even more difficult to recruit or retain personnel.
    In an ESOP, all qualified employees are allocated shares of the company over time. Shares are allocated based on salary (with maximum limits), to allow for key managers to receive enriched compensation in the form of ESOP stock. Key management may also have the ability to be awarded synthetic equity to allow the company to continue to reward its key people.
    This has helped ESOP-owned companies retain their key employees and perform better than their peers. A study from the National Center for Employee Ownership found that productivity improves by an extra 4 to 5 percent on average in the year an ESOP is adopted, and the higher productivity level is maintained in subsequent years. This one-time jump is more than twice the average annual productivity growth of the U.S. economy over the past 20 years.
  • Recruitment. With the current unemployment rate at less than 4 percent, it’s becoming increasingly difficult to attract talent. With wages continuing to increase, employers are looking at more creative ways to differentiate themselves to continue to attract top talent.
    Having the ability to offer candidates participation in the ESOP may provide your company a benefit your competition may not be able to offer. An ESOP is a benefit plan in which shares are allocated to its participants over time. In most cases, ESOP shares are provided to employees and do not require any economic investment by the employees. The benefits of an ESOP can provide for substantial compensation to employees over time, allowing its employees to share in the success of the company.
  • Legacy. An ESOP provides a business owner with the most flexible way to transition a business, as it can be done in a multitude of ways to ensure it aligns with the objective of a selling shareholder(s). While third-party sales may ultimately align with a selling-shareholder’s objectives, it often comes with many changes.
    With an ESOP transaction, the buyer of the stock is a newly-created trust created for the purpose of acquiring shares for the benefit of the company’s employees. The day-to-day management of the company and the executive team can, and typically does, remain unchanged. The selling shareholder has the flexibility to remain with the company in his or her desired capacity for his or her desired time frame, allowing the company to remain on its course and ensuring continuity for the business.

ESOPs also provide the sponsoring company, and potentially the selling shareholder, with significant tax benefits, which will be the focus of Part Two of this series.

Wintrust Financial Corporation is a more than $28 billion financial services company headquartered in the Chicago area. James Swabowski is senior vice president; and Pat Stoltz is managing director of the ESOP Finance group at Wintrust Financial Corporation. They can be reached at jswabowski@wintrust.com and pstoltz@wintrust.com.

Posted in Articles | January 14th, 2019 by