Small-business owners don't usually consider setting up an employee stock ownership plan when they are preparing to retire, but The Principal Financial Group thinks that they will once financial advisers explain the tax benefits.
“ESOPs can help a business owner get the money they need to retire, diversify their portfolio and plan for their eventual business exit,” said Jerry Ripperger, director of consulting for Principal.
The company has launched a program to train advisers how to help clients evaluate whether an ESOP is a good idea.
“Advisers who bring the ESOP concept to their business owner clients are in the position to help them invest the significant amount of assets freed up by creating the ESOP,” Mr. Ripperger said.
ESOPs came into existence in the mid-1970s. By the end of last year, about 11,000 companies had such plans holding combined assets of $869 billion, according to the National Center for Employee Ownership.
ESOPs extend ownership to workers by awarding shares of company stock to employee-owned accounts. The shares are repurchased when the employee leaves. Companies set up the plans by contributing new shares of stock or the cash to buy existing shares from the owners at fair market value, determined by a valuation.
ESOPs offer generous tax breaks that could save a business owner millions in income tax, according to Principal. Company contributions to the ESOP trust are generally tax-deductible, which reduces the cost of selling.
C AND S CORPS
Principal describes the typical ESOP candidate as a closely held C or S corporation that accounts for most of the owners' net worth, especially if they are nearing retirement. The company needs a history of profitability and strong cash flow to manage the debt required to set up the ESOP trust.
Owners of C corporation shares can defer capital gains when they sell if they reinvest in tax-deferred accounts. For S corporations, the ESOP's share of earnings is not subject to federal income taxes or those of many states.
Troy D. Winegarner developed what he calls a “cheat sheet” to help other advisers at his firm recognize the signs that a company might want to think about an ESOP.
“That is an important step, helping personal financial planners recognize opportunities,” said Mr. Winegarner, corporate-client director at the Molle Winegarner Group of Morgan Stanley Smith Barney LLC.
After an ESOP is formed, an adviser can help owners “manage the liquidity event,” he added.
In addition to managing assets acquired by owners, other opportunities usually arise — for example, providing life or disability insurance, or managing deferred compensation.
“There are all sorts of ways it can be profitable for advisers in these situations,” Mr. Winegarner said.
He added that sometimes the owner of a business outside a metropolitan area wants employees to be able to continue working in the same area, which may not be possible with an outright sale.
ATTRACTIVE ALTERNATIVE
Owners typically begin to think about the ESOP option in the three to five years before retirement, Mr. Winegarner said.
An ESOP could be an attractive alternative for those who do not want to sell at current prices, and lack family members interested in taking over the business, said Gary Curtis, a certified public accountant and partner at Haskell & White LLP.
“I think we will start seeing more ESOPs,” Mr. Curtis said. “I see practitioners ramping up.”
Principal in the spring began training advisers on how to manage the plans. They have become a popular topic for advisers seeking different options for owners looking to exit, though Mr. Ripperger said it is too early to see substantial results.
Clif Bar & Co. formed an ESOP in 2010 with 20% of the company's stock to help co-founders Kit Crawford and Gary Erickson diversify their assets and provide for workers of the close-knit business, which makes energy bars.
Administered by Principal, the ESOP has succeeded beyond anyone's wildest dreams, said Rich Boragno, Clif Bar's chief financial officer.
“People were ecstatic, especially tenured employees,” he said. “Now, two years later, the retirement benefit from the ESOP exceeds the 401(k) balance for many of the employees.”
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