Expert Primer on Employee Stock Ownership Plans. Learn the Who, Why, and How of an ESOP.

Employee Stock Ownership Plans provide a powerful strategy that can offer tremendous benefits for both business owners and employees. Watch and learn as Forbes Best-In-State Wealth Advisor Cary Stamp, CFP®, provides a professional primer on the Who, Why, and How of using an ESOP.

TRANSCRIPT:
Hi, I'm Cary Stamp with Cary Stamp & Company, principled wealth advisors in Tequesta, Florida. And if you're a business owner, you advise business owners, you're a CFO or you're an accountant talking to business owners, one concept that you might want to consider when your business owner is planning to exit their company is to use what's called an ESOP.

ESOP stands for Employee Stock Ownership Plan. It means that the business owner of the company transfers some or all of their stock to a pool for the employees by using what's called a qualified plan. I'll get more into that in just a moment.

But what does the ESOP actually do? Well, every company has stock and in almost most small businesses, the owner owns all or most of the stock. The owner at some point probably wants to exit the business either because they want to retire or they just want to cash out. So they've got a few choices. They can sell the business to a third party, or they can sell the business to their employees. There's a lot of owners where it makes sense for them to make their current employees the new owners of their business and have those employees make payments back to them. That's what this strategy is all about.

So what types of companies does this make sense for? Generally, you need a payroll that's at least a couple of million dollars a year. So you're probably looking at employee counts at a minimum of about 25 people. If you've got less than that, the ESOP strategy often will not make sense unless you have really, really highly paid employees in a small business. So that's the first thing is who does this fit for? It can work in pretty much any industry, and it works particularly well with subchapter S corporations or smaller companies because there are also some additional benefits.

Now, why might you want to do this? Well first, because it gives you an instant and immediately identifiable succession plan. You know who's going to buy your business and those are the people that have already been running it. Number two is for the owners of the business that are making the sale, there are some significant tax advantages in using an ESOP type plan. I'm not going to go into all of those in this video, but trust me, for some families, it saved them millions of dollars in transactions.

And how do we do this? Well, the first thing that you do is that the owner of the company takes some or all of their stock and sells it to a qualified plan. Qualified plan means it's a retirement plan similar to a 401k plan or a profit sharing plan at a company, and that qualified plan purchases the stock from the owner. In exchange for that, the owner either gets cash or a stream of payments back to them from the employee stock ownership plan.

Now, when employees retire, if they are participants in the ESOP, they get cashed out by having an ESOP buy back their stock from them and send them cash so that they have money to live on in retirement. So this ESOP is funded by contributions from employee deposits that they would normally put into the retirement plan and all of the stock value and all of the gains and all of the dividends that the stock pays while it's inside of the ESOP are completely tax-free.

Why? Because it's a qualified plan. It doesn't get taxed until it's withdrawn. I should qualify that. It's tax-free while it's paid in there, it's tax-deferred because after it's received out to the employees and employees can roll it to an IRA. If it comes out of there, it's taxable as ordinary income because it's just like anybody coming out of a 401k or qualified plan.

So talk to your accountant, talk to your financial advisor and get some really good advice because there certainly are some pitfalls in how ESOPs work.

And lastly, if you're wondering what some of the big ESOP companies are, Both of these happen to be grocery stores but that doesn't mean that's the only industry that they would work in. Here in Florida is the Publix grocery store, is an employee-owned company. Most of the stock is owned by employees of Publix and many times the cashiers that work at Publix will work there for 30 or 40 years and retire with seven figures worth of stock in their retirement plans.

Another one is closer to my hometown in Iowa, and that's the Hy-Vee grocery store chain in Iowa. It's one of the largest ESOPs in the country. But in both of those examples, it worked great for the founders, it worked extremely well for their families and it has become a phenomenal boon to the employees.

Think about this also. If you're an employee and you own part of the company, it probably gives you an incentive to want to see that company succeed more.