How employee stock ownership becomes a succession plan

As succession strategies go, the employee stock ownership plan might be the ultimate twofer.

For Joe Reeves and Ron Butt, co-founders of Louisville, Kent.-based ARGI, the pursuit of a viable succession plan for their $2.6 billion financial planning firm was the original objective, but the ESOP provided the added bonus of giving all employees a potential stake in the RIA’s ongoing success.

“Stock ownership ties everyone to the same common goal,” Mr. Reeves said.

“We were running into the situation that as we were growing, it was good for shareholders, but it was just more work for everyone else,” he added. “Once we added the ESOP, people started to get excited and thinking like owners.”

The ARGI ESOP, which is structured like a profit-sharing plan, was set up in 2015 to enable the company and its employees to eventually buyout Mr. Reeves and Mr. Butt, who co-founded the firm in 1997.

Mr. Butt, 60, retired last year, but Mr. Reeves, 48, plans to work for another dozen years and gradually sell down his ownership stake to the employees.

(More: Succession plan success story)

Prior to the ESOP, the ownership was split evenly between the two co-founders. In creating an employee stock ownership structure, Mr. Reeves and Mr. Butt each sold 10% of their ownership to the ESOP, which was financed through a bank loan and paid to the co-founders.

Over the past four years, Mr. Butt’s shares were gradually distributed to employees, with his remaining 8% stake acquired by the ESOP upon his retirement.

Currently 15 of ARGI’s 155 employees own stock in the company directly outside of the ESOP, but every employee owns shares inside the ESOP through annual share distributions equal to about 6% of individuals’ salaries.

Currently the ESOP owns 28%, Mr. Reeves owns 32%, and the remaining 40% is spread across the employees who have been issued or acquired shares.

Mr. Reeves compares the distribution of the company shares to a partnership structure, but admits “it’s not an exact science.”

“It’s based on reaching a certain level in terms of quantity of time and quality,” he said.

Share ownership inside the ESOP comes with a vesting period that starts at 20% ownership of the stock after the first year and proceeds to full ownership after five years.

Once an employee retires or leaves the company, the shares are paid out.

Also, employees who own shares are eligible to buy shares that become available, but they are limited to buying the percentage equal to what they already own. For example, if an employee owns 5% of the company, she would only be able to buy the equivalent of 5% of what is for sale.

This is designed in part to prevent any single employee from becoming a disproportionate shareholder.

George Tamer, managing director responsible for strategic relationships at TD Ameritrade Institutional, described ESOPs as a rare but increasingly popular succession strategy.

“The biggest hurdle generally for internal succession is financing the succession to the next generation of advisers,” he said. “An ESOP is a great way to make sure the company stays employee owned, without putting them in financial straits just to buy in.”

(More:​ Sometimes a sale is the best succession plan)

Another potential benefit of an ESOP, is that it can make the company more attractive to an external buyer if the owners opt for that route, Mr. Tamer said.

Mr. Tamer added that ESOP models work best when the ownership succession is many years down the road.

“For older advisers looking to cash out in the next five years, an ESOP won’t be the best option,” he said.

Mr. Reeves describes the ESOP as “100% successful” on several levels.

Beyond the succession plan and giving all employees a stake in the company, the ESOP has introduced a more tangible value for the advisory firm, which Mr. Reeves said is worth about $60 million.

He estimates that it costs about $50,000 per year to maintain the ESOP, but that comes with regular valuation calculations that show the company shares have doubled over the past four year to $32 each.

“We analyzed a lot of different options and this has been great for us,” Mr. Reeves said. “It helps morale, everybody wins together, and now when we find a new opportunity or new acquisition it also creates a legitimate stock price.”

Mr. Reeves said one key to a successful ESOP is that the company should be in growth mode.

“Make sure you’re doing it for the right reasons, because the ownership has to want to incentivize the employees,” he said. “The ESOP doesn’t always maximize wealth, but it does create an environment where everyone is on the same team. Nobody gets left behind, which is really important to us.”