Russell ShawDuring the best of times and during the worst of times, companies with employee stock ownership plans (ESOPs) have proven to perform better than non-ESOP peer companies as measured by profitability, jobs gains and fewer job losses. Long-term studies conducted at the University of Pennsylvania and at Rutgers University have indicated higher profitability, higher job growth and increased longevity with the ESOP business model. During the Great Recession, survey results from the 2015 General Social Survey at the University of Chicago indicated lower lay off rates for ESOP companies compared with non-ESOP companies during 2010 and 2014. Another survey conducted at Georgetown University indicated that ESOP Subchapter S corporations actually added jobs during 2008 while comparable companies in the same industries were cutting jobs.

The National Center for Employee Ownership (“NCEO”) issues periodic reports on benefits in ESOP companies compared to benefits in non-ESOP companies. A recent report indicated that the average contribution by ESOP companies to their ESOPs was approximately 9.7% of eligible employee compensation compared to approximately 4.0% for non-ESOP companies (primarily to 401(k) plans). Thus, compared to employees of non-ESOP companies, employees of ESOP companies are more likely to retain their jobs until retirement and, when they do retire, they are likely to have higher retirement benefits. Further, taxpayers also get relief because unemployment compensation costs will tend to be lower for ESOP company employees.

Despite the apparent superior performance of ESOP companies compared with non-ESOP peer companies, the NCEO has reported a decrease in the number of ESOP companies from nearly 9,000 for 2002 to approximately 7,000 for 2019. The NCEO has also estimated that there are approximately 500,000 closely-held companies in the United States with at least 20 employees. The 20-employee threshold is important because the cost and complexity of forming and maintaining an ESOP excludes many, if not most companies, below the threshold and, in addition, S corporation ESOPs may have difficulty meeting certain regulatory compliance tests if they have fewer than 20 employees.

The coronavirus pandemic and the ongoing threat of COVID-19 warrants a re-examination of both business strategy and public policy with respect to ESOPs and ESOP formations. It is near certainty that U.S. fiscal policy going forward will migrate towards a neo-Keynesian stimulation of aggregate demand (i.e., consumer spending) and increased public funding of health care. The CARES Act and the monetary expansion by the Federal Reserve are only the current manifestations of the former while the Families First Act and the expansion of Medicaid are only the initial steps as to the latter (includes some uncoupling of health care from employment).

Why are ESOPs the solution?

First, ESOPs facilitate business survival and longevity. Over time, this could mean millions of jobs saved and billions of taxpayer dollars saved.

Second, ESOPs offer financial incentives that cannot be matched by any other form of business. These include, but are not limited to, tax deferred or tax exempt stock sales to ESOPs sponsored by C corporations and exemption from federal income taxes (UBIT) to the extent of ESOP ownership of S corporations.

Third, because of the tax and financial benefits, ESOPs facilitate family wealth and legacy planning, including the funding of any charitable interests.

Fourth, ESOPs facilitate the continuation and growth of company culture built by the founders and selling shareholders.

Fifth, ESOPs facilitate the broad-based capital ownership of companies providing millions of employees with both a piece of the action and equity incentives.

Sixth, ESOPs facilitate the continued participation, if not the continued control, of ESOP companies by the shareholders selling to the ESOPs.

Seventh, given that nearly all ESOP companies are closely-held (not publicly traded), the stock value of ESOP companies tends to be somewhat insulated from the volatility of the established securities markets because stock value tends to be determined based on company performance.

Eighth, ESOPs facilitate acquisitions on a tax-efficient basis because, under certain circumstances, ESOP tax advantages can be passed on to the shareholders of target companies and because, as to S corporation ESOPs, there are no adverse tax consequences.

What’s Next?

Please contact our ESOP team and allow us to provide you a safe and secure pathway to attainment of your business and personal goals.

Tim Jochim is a partner in the Columbus, Ohio office of Walter | Haverfield and a national authority on business succession and employee stock ownership plans (ESOPs). Tim can be reached at tjochim@walterhav.com or at 614-246-2152.

Russell Shaw is a partner in the Cleveland, Ohio office of Walter | Haverfield and focuses his practice on employee benefits, which include retirement plans, executive deferred compensation plans, welfare benefit plans, VEBAs, and 403(b) tax-deferred annuity plans. Russ can be reached at rshaw@walterhav.com or at 216-928-2888.