Are ESOPs the Right Choice for Your Client?

From business succession to retirement planning, as a financial professional, there’s a good chance you’ve discussed the possibility of creating an employee stock ownership plan (ESOP) with some of your clients.

While ESOPs may not be the right move for everyone, it’s important that you’re able to outline just why they can represent such a valuable strategy. Otherwise you run the risk of letting one of your clients miss out on what may be the ideal solution to their specific needs.

Opening the door

Although ESOPs have been in use for decades now, they’re not often given the same level of press as other work-related financial tools, such as 401(k)s. This has led to many potential clients being unaware of their benefits.

Your first step will likely be to explain exactly what an ESOP is to your client, as well as how it can be used.

ESOPs represent a way for business owners to cash out for retirement while making employees happy.

ESOPs represent a way for business owners to cash out for retirement while making employees happy.

As its name implies, an ESOP provides a company’s employees with ownership interest in the organization. In this way, business owners can then cash out of their company come retirement by selling their ownership interest to their employees through the plan.

This provides business owners with three primary benefits right off the bat. First, it presents them with a way to obtain much-needed money for retirement. Secondly, it gives them a way to cash out of their position without being forced to sell their company to a competitor. In many cases, the last thing a business owner wants to do is see the enterprise they worked so hard to build go to a business adversary. And finally, ESOPs come with many tax advantages.

For instance, The National Center for Employee Ownership states business owners can defer tax on gains they make from an ownership sale to an ESOP if the ESOP possesses 30 percent or more of a company’s stock, in addition to other requirements. Also, the purchase can be made in pretax corporate dollars.

Reaping the rewards

These benefits and others have led many business owners to utilize ESOPs. The NCEO estimates there are nearly 28 million Americans who own employer stock through an ESOP at their work. The ESOP Association states there are approximately 10,000 ESOPs in place in the U.S.

In addition to the advantages ESOPs can offer business owners, data also indicates they can boost company performance.

“A 2000 Rutgers study found that ESOP companies grow 2.3 percent to 2.4 percent faster after setting up their ESOP than would have been expected without it,” the NCEO states. “Companies that combine employee ownership with employee workplace participation programs show even more substantial gains in performance. A 1986 NCEO study found that employee ownership firms that practice participative management grow 8 percent to 11 percent per year faster with their ownership plans than they would have without them.”

It’s also been shown that having a business succession plan such as an ESOP in place can improve employee morale. A study from Deloitte titled “High-Impact Succession Management: Key Findings and Maturity Model,” illustrated that companies that focus on succession planning generally see positive effects as they relate to worker morale and loyalty.

“The top two benefits of effective succession management in these high-performing organizations are improvement in employee engagement and improvement in career development opportunities,” Kim Lamoureux, vice president of leadership and succession research at Bersin by Deloitte, stated in a media release. “This is good news, because it means that sophisticated succession management programs address the number two priority- after leadership gaps – previously cited by HR leaders in Deloitte’s Global Human Capital Trends 2014 report: retention and engagement. Employees who are provided with performance feedback and are alerted to potential future opportunities within the organization are more likely to be engaged in their work, and therefore more likely to stay with that organization.”

Weighing all the options

Obviously, there will be some instances when using an ESOP simply doesn’t make sense.

For example, some business owners may want to keep operations strictly a family affair, in which case selling the business to employees won’t be the ideal solution.

However, when compared to selling to managers or outside buyers, you are in the perfect position to outline how ESOPs may better serve a client’s needs.

As with all financial planning efforts, the key is giving your clients a wide range of options and helping them understand the pros and cons of each one.

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Highland Capital Brokerage

Highland Capital Brokerage

Highland Capital Brokerage is committed to developing client-focused relationships with financial advisors using our core competencies of life insurance, annuities, and long-term care. We distinguish ourselves by providing point-of-sale support, advanced marketing, and creative estate and business planning techniques.
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