Branching out: an employee stock ownership plan is more than a just great way to boost morale—it's also a cheap source of growth capital

Entrepreneur,  April, 2004  by Crystal Detamore-Rodman

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Even if you've got time on your side, the financial strain created by buying back stock from departing employees is another limiting factor. "The company involved with an ESOP has to realize they have a repurchase obligation that can be a demand on cash flow as the company matures," says J. Michael Keeling, president of The ESOP Association in Washington, DC.

Broader Appeal

Though ESOPs are complicated to install and administer, about 10,000 companies now have the plans, up from just 200 in 1974 Insiders attribute much of the growth to a 1998 rule change that allowed S corporations to sponsor the plans. At the same time, companies recognize they can boost profits by giving employees an ownership stake, which studies have shown enhances morale and performance. "Statistics show if you have a meaningful percentage of ownership and some communication that the employee's job impacts the value of the shares they have in their accounts, these companies outperform their peers by a factor of 10 percent on a compounded annual revenue and [EBITDA] growth basis," says Josephs. "Although they give something up, what they have is going to be worth more."

ESOP FABLES

Among employee benefit programs, the Employee Stock Ownership Plan, or ESOP, is the most misunderstood. Perhaps the most common misconception is that an ESOP will hinder your management style. "[Some people] think employees are owners like the entrepreneur is the owner," says Mary Josephs, senior vice president of the Leveraged Finance Department at Chicago's LaSalle Bank Corp., an ESOP lender. "They share in the stock appreciation of the company, but they do not own the company."

But companies with an "open, friendly style of management" tend to make the ESOP conversion with greater ease, says J. Michael Keeling, president of The ESOP Association in Washington, DC. "If that company had an open environment before they did the ESOP, it will be easier for them to make the transition. But there is no law that mandates how you manage an ESOP company."

Another misstep companies make is skimping on setup fees. "You might save a few bucks dealing with local providers who say they understand ESOPs, but in the long run, you'll pay if your plan isn't done correctly," Josephs warns. "Do your homework, and get recommendations from The ESOP Association and the National Association for Employee Ownership."

CRYSTAL DETAMORE-RODMAN is a Charlottesville, Virginia, writer who covers the small-business finance market.

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