An Employee Stock Ownership Plan (ESOP) is a form of qualified retirement benefit plan which allows employees to become owners of stock in the company for which they work. There are various pros and cons in evaluating whether an ESOP might be appropriate for your company.
A key benefit of an ESOP is the potential for increased employee motivation and productivity, which can lead to enhanced company profits. Other benefits can include the creation of a market for shares of departing owners of the company as well as tax advantages for owners selling their stock to the ESOP arising from the potential for deferral of recognition of taxable gain on the sale of shares. Companies can also realize tax benefits in the form of tax deductions flowing from contributions to the ESOP which, in turn, are used to cover debt payments connected with the purchase of ESOP-owned shares.
When evaluating the suitability of an ESOP for your organization, there are several important elements to consider. The initial costs in setting up an ESOP can be significant. There will also be recurring annual costs connected with valuation of company stock and other administrative matters. In instances where there is no public market for the company's stock, ESOP provisions will require the company to repurchase company stock from employees who are eligible for an ESOP distribution due to retirement, death, disability, or termination of services. The magnitude of the potential cash flow commitment from repurchase obligations can require careful planning.
In addition, it is important to consider some of the unique issues that result from the way construction activities are financed. For example, a potential key element of a construction company's ability to maintain profitable operations lies in its ability to secure surety bonds. Surety companies generally seek to minimize their risk and do so, in part, by carefully evaluating companies seeking bonds to assure they are properly capitalized and have sufficient cash flow to cover all operating obligations, not just costs associated with a job for which a bond is sought.
While a surety may appreciate the potential benefits of an ESOP in facilitating the orderly transition of ownership and management of a construction company as well as the opportunity for increased employee productivity, it may view the implied cash flow commitments negatively. Financing arrangements arising from an ESOP's purchase of company stock typically involve either a direct borrowing by the company (which, in turn, lends this amount to the ESOP) or an indirect credit relationship (wherein the ESOP borrows from a third party and the company guarantees the loan). The related cash flow commitments can have a negative impact in a surety analysis. Depending on the age and turnover rate of the company's workforce, the requirement to buy back the vested stock benefit of departing employees can lead to further concerns.
The potential impact of these considerations has led to a lower rate of adoption of ESOPs within the construction industry than in other industries. Nevertheless, ESOPs can be a valuable planning tool and, therefore, are worthy of consideration in appropriate circumstances.
Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.