ESOPs Put Employees In the Owner’s Seat

BY STEVE DINNEN

Building a successful business is tough. Selling it can be equally challenging. But there’s a way to find talented, dependable people to take over your company—and they’re right outside your office door.

Employee stock ownership plans—ESOPs—do what they say: Put the employees into the owner’s seat.

They follow federal laws that set up the framework for business owners to sell all or part of their business to the people who work for them. And those laws bestow ESOP deals with some decent tax breaks. If the company is a C corporation, for instance, the transaction can be tax-free to selling shareholders who take advantage of Internal Revenue Code section 1042. If the company is an S-corp it can put it on a more competitive footing by shedding its corporate income tax liability, thereby increasing its free cash flow to pay down debt, make acquisitions or prepare for the eventual payout of the employee owners.

Mark Weisheipl, associate director of ESOP Finance at Bankers Trust Co., said studies show employee-owned firms tend to outperform peers. And employee-owners like ESOPs as well because “they are four times less likely to lose their job in a downturn.”

ESOPs known to Central Iowans include Wright Service Corp. (Wright’s Tree Service) and Sammons Enterprises, which operates Sammons Annuity Group in West Des Moines. Hy-Vee Stores Inc. is a variation on the theme; not all workers participate in the ownership plan.

ESOPs seem to work well with firms that are heavier on employees contributing to the bottom line rather than hard assets, such as construction companies, architectural and engineering businesses, and consulting and professional staffing firms. Recently, the ESOP finance team at Bankers Trust assisted Kreg Tool Co. in Huxley as it transitioned to a minority ESOP-owned company. Joe DeJong, Bankers Trust’s managing director of ESOP Finance, said the bank is one of just a handful of banks nationwide that work on financing ESOPs. Outside financing is key, because the way an ESOP works is that the company borrows money to pay the seller.

It’s important that a selling owner runs a profitable concern. There’s no room in an ESOP to jettison a money-losing business onto unwary staffers and saddle the company with debt. Instead, it’s those profits that are used to repay the bank loan, and which are plowed into the investment pool that becomes the stock ownership credit for employee-owners.

There are a number of specialists who get involved in an ESOP sale—lawyers, bankers, independent valuation experts. In addition to all the paperwork, there is a cost, which one industry advisory pegged at $50,000 to $100,000. While that’s not a trivial sum, how much less would it be to accomplish an outright sale? And how would you know that the people you’re selling to are going to maintain the traditions and integrity that built up with the employees at hand?