Blog

Aug 27 2015

ESOPs and Family Business Can Be a Great Mix

Guest post by Corey Rosen, founder of the National Center for Employee Ownership, a nonprofit information and membership organization.

Employee Engagement & ESOPs

When a second generation takes over a family business, employee engagement can be a challenge. Many employees will have been hired, and are loyal to, the first generation. So how can you weld the employees to the second generation? One way is to sell some of the stock to an Employee Stock Ownership Plan (ESOP). Research shows that companies with ESOPs, especially if they encourage employee involvement in work-level decisions, substantially outperform their competitors.

WaWa, the iconic chain of 645 convenience stores in Pennsylvania and other states, traces its roots back to 1803 when George Wood started a dairy farm. In 1964, WaWa opened its first store. In 1992, WaWa set up an Employee Stock Ownership Plan (ESOP) as a means to provide Wood family members a way to sell their shares. The ESOP fit well in what the company calls the “WaWa Way.” In an interview with Knoweldge@Wharton in 2014, former CEO Howard Stoeckel said the ESOP is a big part of that.  “We believe in sharing ownership with the people who deliver the Wawa brand, our associates. They own 38% of the company…We want other people’s dreams to come true.”

Over time, the ESOP will continue to buy shares and increase its ownership percentage. As it does so, it has provided a highly tax-favored way to share ownership, engage employees, and allow WaWa to stay true to its values by staying private.

Tax Benefits of ESOPs

In addition to supporting employee engagement, an ESOP is also a highly-tax favored way to share ownership, meaning it provides the second generation a very attractive way to get liquidity for some of its ownership while retaining control of the company. The most notable ESOP tax benefits include:

  • Sellers to an ESOP that is or converts to C corporation status can defer capital gains tax on the sale by reinvesting in other securities.
  • Redemptions of stock from owners through the ESOP are tax-deductible.
  • Profits attributable to an ESOP are not taxable in an S corporation; a 100% S corporation ESOP pays no income tax.
  • Employees are taxed in an ESOP in the same way they are in other retirement plans.

ESOP governance rules are very flexible and, with very few exceptions, allow owners to determine how the company will continue to be run. Owners often stay on in some capacity even after they have sold all their shares.

Considerations

While ESOPs have tax benefits and can be a great way to encourage employee engagement, they aren’t for everyone. Companies need to consider the costs of setting up an ESOP, whether they can live with the rules, and whether they have the financing to make any share purchases practical.

ESOPs work best in companies like WaWa that place a strong emphasis on treating employees well and valuing their input.

For more information on ESOPS, read these articles from the National Center for Employee Ownership.

Are ESOPs a good fit for your business family? Call us at 215.723.8413 or send us an email at info@dvfbc.com for further discussion.

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