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Pros and Cons of ESOPs

What you should know about tax savings, succession, and employee satisfaction
Credit&Finance

When it comes to saving for the future, a company’s defined contribution retirement plan, like a 401(k), can be a great benefit to employees and draw prime associates to an organization. A less commonly offered retirement benefit is an employee stock ownership plan (ESOP), which enables employees to have an ownership interest in their employer’s company, usually without a cost.

Statistics show ESOPs can be beneficial to both owners and employees, offering tax advantages and improved performance. The following is an introductory article on ESOPs—explaining how they work and outlining the advantages and disadvantages to companies and employees alike.

Not a New Concept
Congress paved the way for ESOPs in 1974 with passage of the Employee Retirement Income Security Act, designed to encourage capital expansion and economic equity among workers. Although ESOPs grew rapidly in the 1980s due to tax advantages passed by Congress, they later waned as further alterations repealed some tax incentives and imposed penalties to prevent abuses of plan provisions.

About 4 percent of private industry provides ESOPs; of these, less than 10 percent are public companies. The National Center for Employee Ownership estimates there are roughly 7,000 ESOPs in the United States, covering about 14 million employees.

Among the more visible or widely known in the food industry are several supermarket chains: Lakeland, FL-based Publix Super Markets Inc.; H.E. Butt Grocery Company (H-E-B) in San Antonio, TX; Brookshire Grocery Company in Tyler, TX; and K-VA-T Food Stores, Inc., headquartered in Abingdon, VA.

Publix is the largest and one of the oldest employee-owned companies in the United States. Way back in 1933 founder George Jenkins offered employees a $2-per-week raise to buy shares in the company, which later evolved into an ESOP. In the 85 years since, shareholders have enjoyed a substantial return on investment.

How ESOPs Work
When creating an ESOP, a company establishes a trust and hires a trustee, which can be a bank, other financial institution, or the company’s upper management. The trustee has the fiduciary responsibility to manage the plan and its assets for the benefit of its participants.

The trust acquires some or all of the operating company’s stock at a fair market price based on a valuation from an independent appraiser, which must be performed annually for privately held companies. The company can contribute new stock to the ESOP or provide cash to buy existing shares. An ESOP can also purchase stock from the company or its shareholders with a loan (called a leveraged ESOP).

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