“I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.” Abraham Maslow
I think of this quote often when I think about Employee Stock Ownership Plans (ESOPs) and how they are used by business owners.
When people consider flexible qualified retirement plans they often think about them as a tool for exit planning. In many ways that characterization is fair as that is how they have been commonly promoted for several decades.
Exit planning is the process of transitioning the ownership of a business.
ESOPs can be a great approach for many business owners to have a controlled exit of their business. The business owner controls the timing and extent of exit. They remain in control of the business. The ESOP lets a business owner exit on their terms.
Yet, to think of an ESOP only in terms of exit planning sells them short. There are at least two other areas where ESOPs can play an important role:
- Assisting a business owner diversify their holdings
- Helping participants prepare for retirement
The average business owner has almost 80% of their net worth tied up in the value of their business*. This is not surprising given that many have had (or wanted) to reinvest earnings to continue to grow their organization.
Often times these owners want to lock into their gains or need to access their business value to fund their retirement. An ESOP may be a good solution in these instances.
For example, assume that the business owner has seen the value of his or her business increase over the years. By putting in a minority ESOP (such as 30%) the owner can lock in the upside gain on that portion of the company.
Similarly, they could use a partial ESOP to generate liquidity to finance retirement needs. If the owner wanted to lock in additional gains in the future or access additional liquidity, they could increase the percentage of ownership by the ESOP.
The ESOP is often a second retirement plan that can help employees build savings for their future.
Employees who have both a 401(k) and an ESOP have 2.7 times the average annual contribution rate compared to someone with access to only one retirement account**.
This additional retirement savings is paid for (to a large extent) by tax savings.
ESOPs have a number of uses making them a flexible tool for a business owner looking to exit their business, diversify their holdings, or assist their employees with retirement savings.
In addition to blogging here, I also tweet regularly about topics of interest to ESOPs @jlripperger.