Web Article
May 10, 2018

Ten Ways to Make Your ESOP Great

On average, ESOPs are wins for everyone—sellers, employees, and the company itself—but the average is pulled up by a handful of stellar ESOP companies. In our 35 years of working with leaders of ESOP companies, we have seen 10 things that can make a good ESOP into a great ESOP.

1. Don't pay off your internal loan too fast.

Your external ESOP loan (from the lender to the company) can be paid off at a different rate than the loan from the company to the ESOP. Paying off the internal loan quickly will provide early participants with very large contributions and later ones much smaller ones. A slower path for the internal loan can manage this problem. Action: Work with your advisors to do an analysis of alternative scenarios before planning on a loan repayment schedule.

2. Create a succession plan for all critical people, not just CEOs.

The best companies have formal processes for key people to identify possible successors and for employees to indicate what kind of career path they hope to take. Performance reviews look at the past, but talking with employees about what they hope to accomplish is not only forward-looking but lets people see their future with the company and motivates them to take responsibility for making that future happen. Not much makes a job feel more fulfilling than having a say in your future. Action: The NCEO publication Leadership Development and Succession provides detailed examples of how to do this.

3. Make sure your culture structures employee involvement, not just allows it.

Too many companies confuse an open-door policy with employee involvement. The best ESOP companies generate lots of ideas from their employees on a regular basis through structured processes. Action: Learn more from company best practices at conferences and case studies in the NCEO newsletter (members area login required). Set up an employee committee to get started with some kind of structure. It doesn't have to be perfect from the outset—start somewhere, then evaluate and change.

4. Make sure your fiduciary process is up to what the Department of Labor expects.

If you have internal fiduciaries, make sure they get the training and detailed ongoing information they need. The NCEO's Inside ESOP Fiduciary Handbook is a good guide. Also make sure you read the Department of Labor's fiduciary process agreement with GreatBanc Trust, reprinted and analyzed in our issue brief The DOL Fiduciary Process Agreement for ESOP Transactions. Action: Consider hiring an outside trustee. The trustee can be directed or independent. The costs are less than most people think, and outside trustees can provide substantial expertise while saving considerable time for people inside the company who would serve as internal trustees.

5. Make sure your distribution policy fits what actually works best for you in the long term.

Too many companies simply default to the longest possible delay in providing distributions. For many companies, this may not be the best approach, especially if your stock is doing well. Action: Consider having a written policy outside the plan that provides for some flexibility in paying off earlier. Talk to your plan administrator and attorney about how this can be done. The NCEO's issue brief ESOP Distribution Policies has sample language.

6. Make sure your valuation reflects your repurchase obligation.

The costs of funding your repurchase plan may be much higher than what you would normally put into a retirement plan. If so, it represents a burden that needs to be reflected in your valuation, or you will put your company in a liquidity bind. Action: Make sure you have an ongoing repurchase analysis, share it with your appraiser, and are satisfied with their approach. The NCEO publication The ESOP Repurchase Obligation Handbook discusses this in more detail.

7. Avoid the have/have-not problem.

Mature ESOPs can end up with newer employees owning few shares and more senior employees with lots of shares. This have/have-not problem creates serious culture challenges, but it can be avoided. Action: Consider rebalancing and account segregation, plus ways to reshuffle shares to move cash from new employee accounts and add cash to the accounts of more senior people. The NCEO's Sustainable ESOPs book has a chapter on this.

8. Consider having outsiders on your board.

The costs of outside board members is relatively low and can help companies deal with issues such as executive compensation, acquisition offers, strategic decisions, and other areas where outside perspective and expertise can be helpful. Action: Consider adding retired ESOP executives, current or retired executives experienced in your field, ESOP experts, and/or people with good marketing or strategic skills to your board.

9. Use interactive communication tools.

Communications that are interactive—games, discussions, having employees explain the ESOP to other employees, web-based tools, and similar approaches—are much more effective than passive approaches, such as handing out material or giving a talk. Action: Set up an employee communications committee to generate new ideas and run the program. The NCEO's ESOP Communications Sourcebook has templates and ideas on ESOP communications.

10. Have a board policy on dealing with acquisitions.

At some point, just about every ESOP company gets a serious acquisition offer. Too many companies are unprepared about how to deal with this, and they end up going into crisis mode. They may spend more time than the company can afford, fail to complete a good transaction, or end up with a decision they come to regret. Especially on the issue of unwanted offers, the set of solutions is much broader if companies engage this issue before the offer arrives. Action: Develop a written policy in advance on what you expect from a suitor to make sure they are serious, and let them know what being an ESOP company means in terms of what they will need to do to make a serious offer. The NCEO has sample language and much more in the issue brief Responding to Acquisition Offers in ESOP Companies, but also work with your corporate and ESOP attorney.