After 20 years of running her consulting business, Jennifer Wise started to think about her next challenge: how to transition her company and retire. As the sole owner and founder of Wise Consulting — an HR and payroll consulting company — Wise said she started looking at options for the future of her business about two years ago. Since she had no family members interested in taking on the Cockeysville, Maryland, company, Wise, now 61, saw several possibilities. She could sell to an outside party or competitor, sell to the management team only or create a structure where all the employees would be come owners.
Last one best one, she said. Wise chose what is commonly known as an employee stock ownership plan, or ESOP. It’s a defined-contribution retirement plan like a 401(k), but instead of participants investing in stocks, bonds and mutual funds, assets are primarily in company stock. Because it’s company stock, employees share ownership in the business that is equal to the proportion of stock in the plan. “I wanted to do the right thing for the employees,” Wise said. “People were very happy that I wasn’t selling” to an outside buyer.
With 10,000 baby boomers retiring every day, Wise is one of many soon-to-retire business owners who are giving the ESOP tires a kick, experts say. While there aren’t statistics to back this up, attendance to the annual National Center for Employee Ownership’s Employee Ownership Conference has doubled in the past five years, said Corey Rosen, NCEO’s founder and senior staff member. “There is a lot of significant interest in ESOPs,” Rosen said.
Today there are nearly 7,000 ESOPs with about $1.3 trillion in assets and 14.4 million participants, data from NCEO shows. There is a wide range of industries using ESOPs, with the manufacturing industry sponsoring the most, and the Midwest holding the highest number at 2,115. About 229 ESOPs have been created each year since 2010.
But in general, not all business owners are making plans for their future, U.S. Trust’s “2017 Insights on Wealth and Worth” survey found. More than half of all business owners, and 65 percent of millennial owners, plan to leave their businesses by 2020, the survey said. Even though protecting their personal wealth is a top concern for them, 7 out of 10 owners said they do not have a formal exit strategy.
Wise said all business owners should consider an ESOP, but some experts disagree. Rosen said ESOPs are not a god fit for top-down cultures because the culture often does not allow a flat business model where ideas to strengthen the company come from every employee. Having that kind of culture makes it easier for employees to feel empowered to offer ideas for improvement to their company, he said. “If you are interested in preserving your legacy and rewarding people, ESOPs make sense,” Rosen said. “Selling to someone else makes all of this go away.”
Litigation, cost and lack of guidance are the trifecta that heavily influences doing an ESOP, experts agreed. ESOPs are not as straightforward as 401(k)s, and things get tricky when stock valuations are done to set the price for the stock to be purchased by the ESOP from the owners. Most lawsuits center on bad stock valuations, said Michael Keeling, president and chief staff officer of the ESOP Association. Often, the Labor Department, which oversees ESOPs, files a lawsuit on behalf of the ESOP against the trustee and/or the owner for the overvaluation. “Sellers can’t be too greedy, and I think that is what happens,” Wise said.
While it’s important to be fair, Keeling said that the Labor Department tends to focus on the offenders more than the thousands of success stories. For example, according to the Labor Department’s “Private Pension Plan Bulletin Historical Tables and Graphs,” ESOPs outperformed 401(k) rates of return 10 out of the 15 years between 2001 and 2015. “No doubt that ESOPs will benefit if bad actors are caught,” Keeling said. “But there are so many good examples out there.” Keeling added he would like to see the DOL issue clearer guidelines for valuations. There are accepted procedures in the industry, but an official best practice guide is what is needed.
Cost of valuations is also a hard pill for many companies to swallow. NCEO’s Rosen said initial valuations can cost between $100,000 and $150,000, and many owners are unable to do that. Wise said she was quoted for valuations going as high as $250,000 before she settled on the best price of $110,000. Meanwhile, Congress has turned its attention to promoting ESOPs with the introduction of two bills in the House and Senate. The House bill is aimed at giving the Small Business Administration broader authority in helping companies establish ESOPs. The legislation in the Senate also empowers the SBA to promote employee ownership.