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The Employee Ownership Report

NewsletterConcisely written for leaders in employee ownership companies and for service providers in the field, the NCEO's bimonthly newsletter, the Employee Ownership Report, is the most efficient way to stay informed about legal issues, current events, best practices, breaking research, management approaches, and communications ideas for employee ownership companies.

Available exclusively to NCEO members, the Employee Ownership Report is delivered in hard copy and all issues back to 1997 are available in the members-only area of the Web site.

Nonmembers are invited to read the sample article below from the current issue of the newsletter. Every time a new issue appears, the sample article on this page will be replaced by one from the new issue. Join online for only $90 to receive the Employee Ownership Report and all our other membership benefits.

Read a sample issue of the entire newsletter (September-October 2015).

Sample Article from the November-December 2015 Issue:

Solutions to the ESOP Have/Have-Not Problem: When There Are No Shares Left

Many ESOP companies, especially those that repaid their "inside" ESOP loan quickly or that made S distributions, find that over years some employees build large holdings of shares while others, generally newer employees, have few shares. This have/have-not problem is a common topic at ESOP conferences, and this article, excerpted from Sustainable ESOPs by Corey Rosen, discusses some solutions.

Buy More Shares: If companies are less than 100% owned by the ESOP, they can always do another share acquisition. In some companies, the seller(s) like the idea of the company becoming a 100% ESOPowned S corporation, but they still want an equity stake. One approach is to have them finance the acquisition with a seller note and get part of their return in warrants.

Contribute More Shares: Companies can also contribute additional shares to the ESOP. This is tax-deductible, but will dilute the ownership stake of other owners. The ESOP will get a bigger share of subsequent distributions as well. The allocation of additional shares can be set up in the plan document so that it is skewed downward. You can, for instance, put a cap on how much pay qualifies for the contribution (so if you contribute 10% of pay, and the cap is $50,000 and I make $75,000, I still get only $5,000). You can also give extra credit for fewer years of service. This approach needs to be tested to make sure it does not somehow favor more highly paid people, which is very unlikely.

Re-leverage: There is a lot of discussion these days of re-leveraging—taking out a new ESOP loan to buy out some or all existing shares in the ESOP and (in one variant of re-leveraging) starting a new ESOP with what has been purchased. So far, few companies have done this, but it is an intriguing strategy for companies with the right cash flow. In addition to getting shares to new people at a now much lower price, it gives existing employees an immediate payout at the current price.

Early Diversification: On a voluntary basis, companies can offer early diversification at any age. Then these shares can be allocated to other employees much as you do with forfeitures. This works well for companies whose stock price growth is strong and cash flow or cash reserves are able to handle the repurchase obligation comfortably.

Forfeiture Formulas:
Formulas for allocating forfeited shares can be set up to favor newer and/ or lower-paid employees, provided the plan administrator tests this for compliance with ESOP allocation rules.

Rebalance: Rebalancing is an increasingly common approach in ESOP companies. To rebalance, at the end of the plan year, shares are sold within the plan for cash so that, within some limits, everyone has the same percentage of stock and cash. For instance, say John has $10,000, all in cash, and Mary has $100,000, all in stock. Overall, 80% of plan assets are in company stock. The ESOP trustee would buy and sell shares within the trust so that John would now have $2,000 in cash and $8,000 in stock and Mary $80,000 in stock and $20,000 in cash.

Account Segregation (Reshuffling): Account segregation (called reshuffling of terminated participant accounts in IRS guidance) applies only to shares held by former plan participants who are still in the plan. In account segregation, the ESOP cashes in these shares and reallocates them to people in the plan who are still working for the company.

Profit Sharing Accounting: In profit sharing accounting, individual employee accounts do not get regular allocations of stock and/or cash. Instead, employees have a percentage of the total assets of the trust, with each participant holding the same percentage of cash and shares. So if the plan has $5 million in assets, of which 20% is in cash, each employee-participant has a share equal to 20% cash and 80% stock. It is preferable to use profit sharing accounting from the beginning of the plan rather than switch to it later, which would involve complex reallocations and compliance with the rules governing them.

IRS Guidelines on Rebalancing and Reshuffling

In 2010, the IRS made it clear that rebalancing and reshuffling are allowable, provided certain rules are met, including these:

It is far better to put rebalancing language in a plan document before you plan to do it. There are still some advisors who believe that taking away the right to shares after they have been allocated is protected. If the plan provides for this in advance, there should be no issue. Nonetheless, many plans do put the language into their plan the year they start to rebalance. Neither rebalancing nor segregation can be used on a targeted basis to move shares out of the accounts of selected participants in order to reduce their ownership to help meet the S corporation anti-abuse rules under Section 409(p) of the code. The policies must apply to everyone.