Employee stock ownership plans are complex mechanisms.
"ESOPs are not just a matter of someone putting stock into an account," Roger Collins, president and chief executive officer of Harp's Food Stores, Little Rock, Ark., told SN. "ESOPs are a government tool to give employees goals that align with the goals of the corporation."
Chris Niemann, chief financial officer of Niemann Foods, Quincy, Ill., cautioned that launching an ESOP can be "fairly expensive" in terms of professional fees for accountants, attorneys and trustees, "and there's a lot you need to understand about all the different facets of it."
ESOPs allow companies to sell some or all of their equity to employees, providing a cost-effective motivational tool, and allowing companies to reduce corporate taxes and increase cash flow and net worth simply by issuing new stock, according to the ESOP Association, Washington.
On the other hand, ESOPs used to finance a company's growth may dilute cash flow benefits. If the value of a stock in an ESOP account appreciates considerably, the ESOP may not have sufficient funds to repurchase stock when employees retire. If the value of a company does not increase, employees may deem the ESOP less attractive than a profit-sharing plan, the association pointed out.
To establish an ESOP, a company creates a trust and makes annual contributions to individual employee accounts within the trust.
Contributions are based on the profitability of the company and on each employee's salary. "The more money a person makes, the higher the company's contribution is. So, a store manager ends up with a bigger share [of the ESOP] than a meat cutter," said Steve Smith, president and CEO of K-VA-T Food Stores, Abingdon, Va.
The most common method for allocating funds to an ESOP is to base contributions on an employee's salary, years of service, or a combination of the two -- usually beginning after the employee reaches age 21, completes one year of service, or has worked at least 1,000 hours.
According to the ESOP Association, two factors make ESOPs unique compared with other employee benefit plans: ESOPs are required by law to invest primarily in the securities of the sponsoring employer; and ESOPs can borrow money to finance corporate projects.
Money invested in an ESOP, like any expense, is deducted from a company's income so companies don't have to pay tax on that money.
"We put the money into a trust, which buys stock in the company, which then goes into each employee's account," Smith explained. "That money stays inside the company tax-free and is available to use as equity capital to be reinvested in the business.
"It's really a double-edged sword because associates get a retirement fund, and the company can recycle that money back into the company without having to pay taxes on it."
Yet, when the company has a bad year, so does the ESOP, Smith pointed out. "There were some years -- when we were making large acquisitions -- that we didn't make any contribution to the ESOP because there were no profits," he said.
Employees are not entitled to receive their shares until they are vested. The length of time for vesting is up to each company, with some vested immediately and others after seven years or more.
Merle Faubel, who recently retired as controller of B&R Stores, Lincoln, Neb., said the value of each company's ESOP stock is determined by a certified appraiser, who looks at where public companies are trading and at the ESOP company's profitability projections for the next five years. "People get a summary plan description each year that tells them how much the company put into the ESOP and what the stock value is per share," Faubel explained.
Employees receive the vested portion of their ESOP accounts at retirement, termination, disability or death, either in lump sums or installments.
When an ESOP employee with at least 10 years of participation in the plan reaches age 55, he must be given the option of diversifying up to 25% of the value of his account. That option continues up to age 60, when the employee has a one-time option to diversify up to 50% of the account.
If an ESOP company is publicly traded, employees may sell their distributed shares on the open market. In a privately held firm -- the case for most supermarket operators with ESOPs -- the company must give employees a put option on the stock for 60 days after distribution and for a second 60-day period one year after distribution, after which the company has no further obligation to repurchase the shares.
