EOT OR ESOP: BATTLE OF THE ACRONYMS
An Employee Stock Ownership Plan (ESOP for short) is an employee retirement benefit plan that gives workers ownership interest in the company. They are regulated by the Employee Retirement Security Act of 1974 (known as ERISA). When a company undergoes an ESOP conversion, all or part of the company is sold to a stock ownership trust that holds individual stock accounts of employee shares until they reach retirement age and/or leave the company.
ESOPs are widely used in the US and can confer significant retirement benefits on the participating employees depending on the value of stock in their account and the fair market valuation at the time they leave/retire from the company. And from the company’s perspective, there are significant tax benefits to be realized, as well as potential benefits from higher engagement and productivity, and the ability to recruit and retain talent, making this a win-win scenario.
However, as we touched on in our post on Organically Grown Company’s transition to trust ownership, there are inherent challenges to installing and operating ESOPs. From the company perspective, they are complex and expensive to administer (typically $150K+ in legal fees to install and roughly $30K to administer annually). ERISA also requires the company to buy back shares from workers that leave or retire. The value of the shares, however, is based on third party valuations, which can fluctuate year-to-year due to company performance and market forces out of their control, which can lead to unpredictable payouts both for the company and the employees. And similar to corporate directors, the ESOP Trustees have a fiduciary duty to maximize profits for the benefit of the employees in the plan. This can result in the company putting fewer resources into other strategic/mission priorities, and/or a decision by the ESOP Trustees to sell the company if the price is attractive or the stock repurchase obligations become too high.
An Employee Ownership Trust (EOT), on the other hand, is relatively simple to install and is significantly less expensive (typically $40 - $60K in legal fees to install and about $5 - $10K annually to administer). Instead of being based on individual stock ownership allocation, all the shares are held by the Trust (as the “steward owner”) for the purpose of providing for ongoing worker benefit. There is no need for employees to retire or leave the company to reap the economic benefits - they simply receive profit-sharing as they go. Employers can also choose to make contributions to a 401(k) plan on their behalf to balance real-time rewards with retirement benefits.
From the employer perspective, EOTs are not a retirement plan and are therefore not regulated by ERISA; there are no ongoing stock repurchase obligations and thus the company avoids the expense of annual valuations. And because profits are paid out as compensation at the corporate level, they are tax-deductible.
Fundamentally, EOTs take a longer-term perspective than ESOPs, with the goal of preserving the company’s ongoing purpose and independence to benefit current and future generations of workers. This is a critical difference. Whereas an EOT is all about perpetual independence, ESOP-owned companies can be (and often are) sold. And while the sale of an ESOP may be viewed as a success for current employees, who stand to reap substantial payouts, it often represents a loss for those who see ongoing employee ownership as the key to enabling workers to build wealth and to capture their fair share of the value they bring to the company, not just today, but for generations to come.
There have been a number of high-profile ESOPs sold in the past few years causing concern among the employee ownership community, perhaps none more so than New Belgium Brewing, which sold to Kirin Holdings, a Japanese conglomerate, in December of last year. Great insights can be found on both sides of this issue in, Last Call: The Forum on The End of Employee Ownership at New Belgium on the Fifty by Fifty blog.
