With over 120 panels at each NCEO annual conference, there are lots of great insights about employee ownership. This issue brief compiles a selection of great ideas from a wide variety of panels on administration, community involvement, culture and communications, fiduciary duties, financing an ESOP, valuation, and other employee ownership issues at the NCEO's 2016 annual conference in Minneapolis, MN. The materials are drawn directly from the presentations, other than minor editorial changes to provide context or ensure flow. The goal here is not to present a summary of basic ESOP issues but rather to look at best practices in dealing with often-challenging matters.
Table of Contents
Common Administrative Errors and How to Avoid Them
Diversification: Rules and Trends
What to Expect from a DOL Audit
Using Prequalified Plans for ESOP Determination Letters
Timeline for Ongoing ESOP Reporting
Employee Ownership and Community Involvement
Culture and Communications
Ownership Culture Committees at SRC Holdings
Measuring and Building Trust in Employee Ownership Companies
Designing a Great Bonus Program
Tina Fey's Rules of Employee Engagement
Fiduciary Issues in Stretching Out ESOP Loans in Second-Stage Transactions
Best Practices for ESOP Administrative Committees
DOL Compliance Issues in ESOP Valuations
Financing an ESOP
Private Placement Financing
Using Warrants in ESOP Transactions
Employee Ownership Concepts
Selling the Idea of ESOPs
Maintaining Your Status for Set-Aside Programs
Preparing Defensible Forecasts for Appraisals
About the Editor
About the NCEO
From "Diversification: Rules and Trends"
There are a number of recent trends in how companies do the diversification. For instance, the criteria may have been a participant aged 55 with 10 years of participation. The new rule could be an employee aged 55 with 10 years of participation (so former employees still in the plan do not have to be covered). The definition used for a "year of participation" may also be changed from a participant with an account balance to an employed participant with an account balance or to a participant eligible to share in the allocation of employer contributions and forfeitures.
Some companies are also extending diversification and/or offering it earlier. That may be an effective way to control the repurchase obligation in companies with a growing stock value, as well as making more shares available for new employees. Companies are also moving away from offering investments in the ESOP in favor of rolling the money in a 401(k) or IRA.
Timing the election is always sticky. Stock valuation and year-end allocations often are not completed within the 90/180 day time frame required by the law. Potential options to meet this requirement include:
- Have the valuation completed within the given timeframe;
- Issue a preliminary election form for completion within the 90-day election period (this could be made revocable);
- Implement a preliminary election with respect to the stock balance from the most recent allocation; and/or
- Implement a preliminary election with respect to the stock balance from the most recent allocation and/or send out final diversification elections (to those who made preliminary election) once the year-end allocation is completed, and process distributions/transfers as soon as possible.
What happens if you don't notify participants they are eligible? You could provide an election opportunity to them as soon as possible and make them "whole" if the stock value declined. Ask counsel if any correction for lost earnings or updated value is needed if this is past the 180-day period.
Another common question concerns a participant who is eligible for both a distribution and a diversification: Do you pay both? Pay one and then update his or her balance and pay the other? Can one satisfy the other? Should your measure be the greater of both? Your policy should make sure you do not overpay and that timing requirements for diversification are met.
For example, assure Mary has 1,000 shares in her account when she separates in year zero. Distributions are handled via five annual installments of 200 shares; she receives an installment distribution of 200 shares in each of years one, two and three, leaving 400 shares in her account at the end of year three. In year four, she is eligible for an installment distribution of 200 shares. Assume she is also first eligible in year four to diversify 25% of the shares "ever allocated" to her ESOP account (i.e., 1,000 * 25% = 250 shares). The distribution shares (200) and diversification shares (250) sum to 450 shares, yet there are only 400 shares in her account. Now what?
You can prorate the 400 equally (i.e., distribute 200 and diversify 200). Or you can diversify the 250 first, and distribute the remaining 150. Finally, you can make a timely distribution of the 200 shares and allow this to offset the 250 available for diversification, resulting in a net diversification amount of 50 shares.
Finally, you need to decide on how to count years of participation in the case of rehires:
- Should you keep counting while they have a balance?
- Should you not count in years they are not employed?
- If they are paid out, does counting stop while they are gone and resume when they are rehired?
- If they are paid out in full, do you add back past shares paid out or start over?
Any of these can work, but you need to have a policy determined in advance and discussed with counsel.
From "Designing a Great Bonus Program"
The secret to a great bonus plan is that people support what they create. Incentive plans alone won't improve performance. An incentive plan can help if people know the company's most important goals, are enthusiastic about those goals, ad can see how they can support those goals. People need to feel empowered to work toward them and understand what they stand to gain if they reach them.
A great bonus plan creates wins, is self-funding, ensures the company's profitability first, and has critical numbers within the employees' lines of sight. The focus should be on gainsharing, not profit sharing. Minimum performance must provide for the profit/cash needed for continued growth and sustainability of the company. Ask yourself what cash investments you plan to make in the plan year that are not included in your profit and loss statement. The real payoff is the generation of wealth in the form of equity. That means you need to watch cash flow and business fluctuations and test the plan.
If you can meet the minimum performance target, make the rewards meaningful. At SRC Holdings, they aim for 50% of the additional profits generated above its required "minimum" performance. The target is 10% to 20% of salary, or about one to two months of additional pay!
Focusing on one or two critical numbers helps. These can be anything, not just an income statement measure. Critical numbers are things that are essential measures of how your team is performing and/or critical issues that need improvement. Use the bonus to teach people about the business. Your bonus plan may be the most effective educational tool you have. Create a "line of sight" between what people do and how the numbers change. Teach people to "check the entitlement attitude at the door" and put the "what's in it for me?" (WIIFM) in the right perspective.