"Any customer can have a car painted any color that he wants so long as it is black." – Henry Ford.
Fortunately people who design employee stock ownership plans (ESOPs) take a different approach than the one advocated in Henry Ford's famous quotation. They embrace the flexibility that ESOPs afford which allows them to craft programs to address the specific needs of the company, the owner, and the employees.
Let's look at several areas where an ESOP allows for flexibility.
- The reason(s) for establishing the plan. Although many tend to think of ESOPs for succession planning only, these plans can actually be used to help a business owner achieve several objectives. In addition to providing a way to pass the business along, an ESOP can create liquidity so that the business owner can diversify his or her holdings. The plan can also play a key role in helping employees prepare for retirement.
- How much of the company to sell. It can be difficult to find a third-party buyer who is interested in purchasing a minority position in a privately held company. As a result, the owner may be facing a situation where they can't achieve their personal goals. An ESOP allows the owner to sell any or all of the company to the plan. Often times the ESOP initially holds a minority position only to become the majority owner at a future date.
- Whether to use debt or not. Although many ESOPs are leveraged (they use debt to finance the transaction) there is certainly no requirement to do so. A non-leveraged ESOP provides the company with a great deal of flexibility. The company can contribute in good years and not in other years in addition to varying the amount it funds (as a qualified retirement plan, contributions should be regular and meaningful).
- How to finance a leveraged transaction. A leveraged transaction allows the owner to get immediate liquidity. The transaction can be financed through a bank or other third party lender. The selling shareholder may also wish to finance part of the transaction. This allows the seller—the business owner—to take advantage of the capital gains tax treatment on the sale and generate ordinary income on the loan's interest payments. Alternately, the bank may finance part of the transaction with the seller financing the rest.
- Which employees get to participate in the plan and to what extent. The ESOP has the same flexibility available to other retirement plans when it comes to eligibility and benefits. As a qualified retirement plan it must be able to pass coverage testing and a general nondiscrimination test.
Just as we all want the flexibility to choose the color of our car, business owners want the flexibility to sell all or part of the business on their terms. An ESOP offers many shades of gray for plenty of choices.
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