How to know if an ESOP is right for you

There is an inherent independent streak among residents of the Live Free or Die state.

So perhaps it shouldn’t come as a surprise that, as a growing number of local business owners start to consider succession planning —a substantial portion of residents will reach retirement age in the next decade — Employee Stock Ownership Plans, or ESOPs, are getting more attention than ever. Last year alone, three New Hampshire-based companies became ESOPs, joining well-known, home-grown brands like Yankee Publishing (which owns NH Business Review), Hypertherm and Littleton Coin (which is one of the country’s largest coin retailers).

For business owners who want to retire while maintaining the company’s independence, ESOPs can offer an ideal option: an exit strategy that provides liquidity to the owners, while keeping the operations, management and culture intact.

New Hampshire now has approximately 30 ESOPs, representing approximately 4,800 participants, holding more than $1.1 billion in assets, according to the National Center for Employee Ownership. Companies that have transitioned to ESOP ownership come from a wide variety of industries, from manufacturing to construction to gardening supply companies.

Given the tight job market — there are still two jobs for every job seeker in New Hampshire — ESOPs are particularly appealing because of the potential recruitment and retention benefits. Once a company adds an ESOP to the list of employee benefits, employees begin to gain a vested interest in the company’s success.

Studies show that individuals who work at ESOP-owned companies have longer job tenure than those who work at non-ESOP-owned companies. Voluntary quit rates at ESOP-owned companies are roughly one-third of the national average. What’s more, the employees who are part of ESOPs tend to fare better financially: Individuals who work at ESOPs have higher household net worth and higher incomes, research shows. But ESOPs aren’t a cure-all for all business owners who are considering succession options. Before going down this road, it’s important to carefully consider whether an ESOP is right for you. After working with ESOP-owned companies across New England, we have identified a few common denominators that successful ESOPs share. Here are some factors to consider:

1. Size matters. It’s important to determine whether your company is large enough to support an ESOP, in terms of number of employees and your company’s financial performance. While ESOPs do come in all sizes, we have seen that the most successful ESOP-owned companies tend to have at least $1 million in EBITDA (earnings before interest, taxes, depreciation and amortization) and at least 25 employees. Why? First, there are added ongoing costs of implementing an ESOP that will need to be absorbed. Secondly, having a financial foundation ensures that you have sufficient cushion so that if something happens — say sales are slow, or you have unexpected capital expenses — the ESOP-owned company is still able to pay back the debt that was taken on to buy the company’s shares. In terms of number of employees, having a large enough team is important, because it generally helps the ESOP and company avoid annual compliance testing failures.

2. You’ll need leaders who are ready to take the baton. While the ESOP provides the financial structure for business owners to sell their company, it is still critical to have people in place who are ready to lead the organization on a day-to-day basis before, during and after the ESOP transition. Because culture and buy-in are the core to leveraging ESOP benefits, succession planning and leadership development are particularly crucial ingredients. If you’re considering an ESOP, think carefully about who in your ranks would be ready to take the helm. Who on your team is effective at inspiring, motivating and managing people, and who could help cultivate the participative nature of ESOP culture at your company?

3. You’ll need the capacity to tap outside help. By law, an ESOP-owned company must appoint a trustee to oversee the plan assets (company shares). A trustee, among other things, oversees the annual valuation process, sets the share price, and can help the company to coordinate with attorneys, financial advisors, accountants and the third-party administrator. Some business owners, in a bid to save money, try to handle this in-house, tapping a member of management to take on these responsibilities. Many companies that try this approach find that it’s just too much risk and work for leaders to handle on top of their day-to-day responsibilities of managing the company. An independent ESOP trustee can focus solely on the ESOP details, while staying knowledgeable of regulatory changes and industry best practices that will help the ESOP company avoid regulatory challenges.

Tabitha Croscut is a shareholder with the law firm of Devine Millimet & Branch, P.A., and Laura Pfeiffenberger is a senior vice president and ESOP client advisor with Spinnaker Trust.