Blue Ridge ESOP Associates Industry News

The Future of Employee Ownership through ESOPs

Posted by Tom Roback, Jr.

Mar 31, 2020 9:22:36 AM

Future MagnifyingEmployee ownership through Employee Stock Ownership Plans (ESOPs) has stood the test of time and is built to last. ESOP champion elected officials on both sides of the aisle stood up for ESOPs during the 2017 tax reform process and ESOP law is still strong. While private company ESOP growth has not grown tremendously, the number of private company ESOP participants has grown to over 14 million employee-owners with wealth over $1.4 trillion. This tax efficient exit strategy continues to be a viable structure for business owners who value the employees who helped them grow the business and want their legacy to last. Research has shown that employee ownership through ESOPs increases productivity, helps secure a more respectable retirement, and keeps more jobs local. The National Center for Employee Ownership (NCEO) found that ESOP companies have almost 20% more revenue growth than the S&P Small Cap 600. During the last recession ESOP companies enjoyed double-digit revenue growth while other businesses contracted. Employee-owners have over twice the average retirement balance than non-employee-owners and 33% higher income from wages. ESOP companies cover a broad range of industries like Manufacturing (22%), Professional/Scientific/Technology (19%), Finance/Insurance/Real Estate (16%), Construction (11%), Wholesalers (9%), Retails (6%) and almost any other industry you can think of.

ESOPs were put in the Internal Revenue Code on Labor Day of 1974 when the Employee Retirement Income Security Act (ERISA) passed in Congress. Along with strong regulation governing retirement benefits and other worker-protection measures, the law established a formal legal framework for ESOPs. The Act was the first piece of legislation to grant special status to the structure.

In 1981 The Economic Recovery Tax Act (ERTA) and the “Roth-Kemp Tax Cut” expanded provisions for ESOPs. The Tax Reform Acts of 1984 and 1986 provided new incentives to expand ESOPs further. The Taxpayer Relief Act of 1997 was refined in 1998 to allow the S Corporation ESOP which allowed the shares owned by the ESOP Trust to be completely tax-exempt for federal tax purposes. While there have been few laws passed with specific ESOP provisions for almost 2 decades, the last few years has seen increased ESOP interest in dealing with wealth inequality, job growth and business transition. The regulatory support for ESOPs has been healthy for a long time and it was exciting to see the 2018 Main Street Employee Ownership Act as another example of the bipartisan efforts to promote employee ownership. The ESOP Association continues to stay on “offense” and continues to present bipartisan bills to promote the formation of ESOPs. Recently 13 states introduced or enacted ESOP-friendly bills or regulations. Even though ESOP law is federal, these state centers are important to get the word out on employee ownership at the local level.

There are several drivers which should help expand the ESOP market in 2020 and beyond. First of all, small and medium businesses continue to increase. There was an increase of over 1.5 million of these businesses from 2011 to 2016. In addition, there has a tremendous increase in the 55-64 year old business owners over the past 20 years.  In 1996 this age group represented less than 16%, but now this age group is almost 30%. Of the 31 million small and medium sized businesses in operation as of 2016 over 1/3 are owned by people over 55 years old. The favorable tax treatment for ESOPs should also continue to attract more business owners to form an ESOP. ESOPs can provide a tax efficient exit strategy for owners including deductibility of principal and interest payments on the ESOP loan for the company. Positive regulations and bipartisan support on the Hill should also help to keep the ESOP market healthy.

Dolores Lawrence and I watched Bernie Sanders present at the Vermont Employee Ownership Conference in June of 2018 and Bernie said, “When employees own their own companies… workers become more motivated, absenteeism goes down, worker productivity goes up, and people stay on the job for a longer period of time.” In 2016 the Republican platform shared that "Republicans believe that the employer-employee relationship of the future will be built upon employee empowerment and workplace flexibility. We therefore endorse employee stock ownership plans that enable workers to become capitalists, expand the realm of private property, and energize a free enterprise economy". Sometimes Republicans and Democrats like ESOPs for different reasons, but it is one of the few concepts both protect.

The older baby boomer business owners will exit the workforce soon and ESOPs are often an ideal way for them to protect their proud legacy, in contrast to selling to a competitor. The younger baby boomers tend to like ESOPs because they often care about sharing ownership for the greater good. Employee ownership resonates with millennial employee-owners who seem to be looking for life balance and a way to feel good about their jobs. ESOPs have had a successful history and they are expected to play an even greater role in the U.S. economy in the future.  Long live ESOPs!

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