Additionally, ESOPs are complex undertakings and must vigilantly comply with written procedures and both Employee Retirement Income Security Act and Internal Revenue Service rules.
Running afoul of regulations can result in lawsuits and/or loss of the plan’s tax-qualified status.
Costs & expenses
The plans also can be costly to establish and manage. The requirement to repurchase shares from departing employees can be a major expense. PNC Bank notes that businesses with consistent and predictable earnings are better ESOP candidates because “they are well-positioned to service the transaction debt and future repurchase obligation requirements.”
Like all defined contribution plans, there is no guarantee of returns. The value of an employee’s account rises and falls with the company stock pricing. There is little, if any, diversification to spread risk. A corporate failure can wipe out retirement savings. To protect employees nearing retirement, current regulations allow those 55 years or older with at least 10 years of ESOP participation to have some of their account diversified into other securities.
Many employee-owned companies also offer a 401(k) to counter risk. Triple T Transport provides both. “The 401(k) is important for diversification, so employees don’t have all their eggs in one basket,” says Amelung.
Risk vs. Reward
Establishing an employee stock ownership plan may be a good choice for a business owner looking for an exit strategy that offers liquidity, flexibility, and tax advantages, while maintaining the legacy of the company he or she built.
Establishing an ESOP is shown to improve company performance, maintain job stability, and offer employees a tax-deferred opportunity to build wealth for retirement. But the advantages must be weighed against other considerations specific to each company and its owner. Any business considering the establishment of an ESOP should consult with an expert to determine the suitability of doing so, clearly outlining all the advantages and possible disadvantages.
