Blue Ridge ESOP Associates Industry News

Variance in Benefit Levels

Posted by Dustin Pirie

Oct 28, 2022 1:37:55 PM

financial_accountingWhen comparing ESOP benefit levels there is variance across all ESOP companies and even within the same ESOP company from year to year. This article is intended to highlight the key factors that contribute to benefit levels and provide reasoning for the variance.

1.   The ESOP is leveraged

If the company currently has an ESOP loan(s), then the ESOP is considered leveraged. The total shares outstanding aren’t fully allocated to participants and a portion of the shares are in suspense. When the company contributes to the ESOP trust and the ESOP trust makes loan payments on the ESOP loan, shares are released from suspense. The contribution and the share release are a portion of the ESOP benefit level. Having a leveraged ESOP provides a consistent number of shares allocated. The number of shares being allocated from the loan is foreseeable, however, the value of the shares being allocated will depend on the updated valuation. The company might release the same number of shares each year, but the value of the shares might have variance. If the company is not leveraged or doesn’t have an ESOP loan, then the benefit will more profoundly depend on when participants elect to take distributions and the demographics of the plan.

2.   Demographics of the plan

In the last several years of our economy, it has been common to experience more retirements and higher turnover of employees. Since shares elected to be taken as a distribution may be reallocated back into the plan, benefit levels can vary based on the timing of participants electing to take distributions. The combination of increased retirements and turnover contribute to benefit levels that are greater than the normal average.

3.   ESOP Repurchase Strategy

The company has options regarding repurchase strategy and the rate at which shares are reallocated back to the plan or retired, which has an impact on a benefit levels for ESOP participants.

Recycling is the practice of using cash in the ESOP trust to convert participants out of their stock position at the time of distribution. Over time, cash normally is put into the ESOP trust as an employer contribution or dividend/Sub S distribution. The cash in remaining participants' accounts is used to buy the stock of the departing participants and in effect are “recycled” since the net effect to the overall shares held in the ESOP Trust is zero after the transaction. In this process, company stock does not leave the ESOP Trust and the distribution is processed in the form of cash.

Redemption is the practice of the company purchasing the shares of departing ESOP participants and retiring them, thus removing them from the shares outstanding. In this process, company stock leaves the ESOP trust as a stock distribution to the former ESOP participant.

Releveraging involves having the ESOP purchase shares from the company with an internal loan. The shares can be from current repurchase obligations, or they can be from treasury. Often, we see that if a company has a redemption strategy, they will later add shares back to the plan. They accomplish this using a releverage strategy. In this process shares remain outstanding for valuation purposes but aren’t immediately reallocated to participants of the plan.

4. Equity Value and Eligible Compensation

Typically, the greater the range of the ESOP equity value to the plan’s eligible compensation, the greater the benefit level potential. On average we see mature ESOP companies, whose plan has been effective for 10 or more years, repurchase 5-9% of the ESOP allocated value each year. This number will depend on the demographics and turnover of the plan. Looking at the ESOP equity value to eligible compensation multiple will help to determine the appropriate ESOP strategies to target desired benefit levels. Below are two examples of ESOP companies and benefit levels. Company A has an equity value to compensation multiple of 2.5X and Company B has an equity value to compensation multiple of 10X.

Consider two 100% ESOP companies:

Company A has an ESOP Equity Value of $5M and $2M of eligible compensation. If the company releases 1/20 of the value from suspense, the value allocated to participants is $250,000. The value of the shares released as a percent of eligible compensation, also known as the fair market benefit level, is 12.5%.

*Assuming all the shares are allocated and the company recycles 6% of the ESOP company value, then the fair market benefit level is $300,000, or 15% of eligible compensation.

Company B has an ESOP Equity Value of $20M and $2M of eligible compensation. If the company releases 1/20 of the value from suspense, the value allocated to participants is $1M. The fair market benefit level from the share release is 50%.

*Assuming all the shares are allocated and the company recycles 6% of the ESOP equity value, then the fair market benefit level is $1.2M, or 60% of eligible compensation.

It is important for ESOP companies to know the benefit levels they are providing their participants. Blue Ridge ESOP Associates can assist you in this understanding with our ESOP Repurchase Obligation services. Please contact your Blue Ridge ESOP administrator for more information.

Topics: Repurchase Obligation, Leveraged ESOP