With the stock market tanking and the LBM world in the doldrums, one might think this isn't the time to buy into an Employee Stock Ownership Plan, or ESOP. That might not necessarily be the case, however, especially if your company is still making solid sales and turning a profit. The keys are exactly who employees are paying when they begin the process of taking over the company and when those notes are due.
In today's environment, starting an ESOP can work when it's an arrangement between employees and an owner who is willing to sell but not in a hurry to get out of the business–an owner whose best interests are the company and his employees maintaining their jobs. In such cases, the owner might not demand a full buyout when the company has a lean year or two.
But if the company is being bought out through a bank loan, it's a different story. "If you are not making that money, then you are not going to be able to make that payment," says Todd Merriss, general manager and vice president of Dixie Lumber in Easley, S.C., which began the process of becoming an ESOP in 2006. "And banks are calling a lot of notes due now.
"During a downturn, your main concern is serving a debt," Merriss says. "And you have to have the cash to pay down the debt."
Facing a possible takeover in the 1980s and the threat of personnel being cut, the employees at GBS Lumber in Mauldin, S.C., went the ESOP route. Led by Olin "Ron" McNeely, then the general manager, employees bought the company from a group of owners via a 10-year loan. Today, the company is 93% ESOP owned.
"We made it happen through several transactions over the years," says McNeely, who today is president and CEO of GBS Lumber. Ultimately, GBS was given more than the 10-year term to pay off the loan.
But ESOPs are not for everyone, says Michael Coffey, managing vice president of Corporate Capital Resources in Roanoke, Va. For the past 25 years, Coffey has helped establish ESOPs, overseeing nearly $500 million in transactions.
As a general rule of thumb, to be a viable candidate for an ESOP, companies should have at least 20 employees and either more than $250,000 in pre-tax income or a value of at least $1 million. But there are exceptions to the rule.
Dixie Lumber, with 15 employees, began the ESOP process in 2006. With roughly $6 million a year in sales, the company is currently paying off the initial 51% of its note, with eight years remaining on the payment. Once completed, Merriss says Dixie employees will buy the remaining 49% stake in the company.
Going ESOP has tax advantages. According to Coffey, some companies are paying between as much as 35% to 45% on "taxes on the dollar." But when an ESOP acquires stock, it becomes a single, tax-exempt shareholder, with the sponsor being an S or C corporation. In the case of an S corporation, when a stock is sold, the seller can receive capital gains tax treatment. C corporation sellers can either pay capital gains taxes, Coffey says, or create a 30% or larger ESOP with proceeds being rolled over tax free.
"ESOPs can make a company tax-exempt, which is a considerable appeal," Coffey explains. Adds McNeely: "It's a good way to save some tax and provide employees with a retirement plan."
Another area that sets an ESOP apart is how its stock is valued. Unlike publicly traded stock, where the market sets the values of shares, an ESOP's stock is appraised by an independent firm based on the profitability and health of the company and how it compares to similar companies in its region. According to Coffey, the appraiser should know the company inside out while having multi-year experience in appraising ESOPs.
ESOPs also face the challenge of keeping cash liquid. "You have to make sure the money will be there for you when the person retires," Merriss says. While stock in a company is often a piece of paper that can be cashed in when the owner decides to sell, stock in an ESOP must be bought out and paid off typically within three years after the employee retires.
"We either have to have that money in a trust for them or come up with the money through profits," says Jim Van Landingham, president of Builders Supply Co. of Petersburg, Va. "The repurchase obligation facing us is very real."
"An ESOP can be a lot of dollars," McNeely says. "If business goes poorly, the dollars are going the other way. But in growth years, some employees have received bigger contributions than they did in comparison to the increase in their salaries."