Demand for top talent is tight in the current labor market. In addition to significant tax benefits, ESOP-owned companies possess a unique advantage to help attract top talent and retain strong managers.
In structuring a sale to an ESOP, several benefits can be layered in to incentivize future leaders to stay and profit from the company’s growth.
Here are two tools that are often used in structuring an ESOP transaction:
1. Management incentive plans. We often see a separate management incentive plan that is tied to share price to motivate and reward key employees. The value may be received in the form of phantom stock or stock appreciation rights (SARs) that typically vest over a period of time.
These plans can be very attractive to management but should be used with caution and be well planned. The benefits of an ESOP are intended to be available to all rank and file employees, and the IRS can impose significant penalties if benefits are concentrated within a small group of individuals when considering these phantom stock type arrangements.
2. Detachable warrants. These are sometimes used as part of the financing in an ESOP transaction, allowing sellers to receive a “second bite of the apple” and take part in the company’s future growth. Warrants are also tied to the company’s share price and any increase in value is taxed at the favorable capital gain tax rates upon exercise. While warrants provide flexibility and enhanced cash flow to sellers in an ESOP transaction, they can also be transferred to leadership to further incentivize the company’s growth.
One of the most powerful benefits of an ESOP is the annual share allocations, available to all employees eligible to participate in the plan. Annual share allocations are typically tied to compensation so that management can receive significant value over time, considering their length of service as well as company performance. The annual share allocations are a benefit enjoyed by every employee of the company, requiring no contributions on the employees’ part (such as in a 401(k) plan). Further, the benefits received are not taxed until retirement and distribution from the plan.
An ESOP can greatly enhance your company’s overall benefit package, helping to both attract and retain key employees. Participation in an ESOP company provides not only financial incentives but can also bring a stronger sense of belonging and pride of ownership.
Katrina Samarin can be reached at Email or 215.441.4600.
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