Best Practices for Considering and Implementing ESOPs

Employee stock ownership plans (ESOPs) are employee benefit plans that buy a portion of a company’s shares for employees that become vested overtime. These plans have many advantages for businesses, business owners, and employees. Following are three steps that companies should take if they are considering an ESOP implementation.

ESOP Best Practices

Seek Knowledgeable Advice

Companies should seek advice from knowledgeable consultants experienced with ESOPs, considering the various related legal and tax complexities. Establishing a team of legal and financial professionals who are well-versed in ESOPs will be the foundation of success for the plan.

Evaluate ESOP Candidacy

Most of our ESOP clients are in industries that recognize strong employee loyalty but low 401(k) participation — attributes that contribute to ESOP candidacy. Financially, only businesses with strong, stable cash flows make for strong ESOP candidates. Without the assurance of increasing profits in the future, employee ownership will not work as ESOPs will not directly provide growth opportunities for the business.

Companies should conduct a feasibility study in the initial phases of the process to ensure the cash flow and capital requirements are strong enough to sustain an ESOP.

Consider Owner Ideology

The success of an ESOP is heavily reliant on the business owner’s ideology. ESOPs work best when the owner wishes to leave a legacy with their life’s work and have a sense of paternalism for their company and employees. Owners with strong, long-lasting, and trusting relationships with their employees may feel a sense of pride in setting their employees up for future success, instead of passing their business to a third party. Because the ownership will remain with the employees, the owner can slowly ease out of ownership at a pace that works for them and the business. The company culture may also have a higher likelihood of remaining intact.

Though ESOPs have many benefits, they are not ideal for every business or every industry depending upon the owners’ succession timeframe and financial goals, and the employees’ interest in ownership. If you have questions or would like more information on ESOPs, contact your DHG advisor or assurance@dhg.com.

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