ESOPs can provide various benefits for organizations regarding succession planning and a wider company culture. In some cases, in terms of employee morale, they can be a powerful tool for retaining and attracting top talent. By offering ownership in the company, employees are more likely to feel invested in the firm’s success, leading to increased motivation and loyalty.

ESOPs also provide employees with a direct stake in the company’s success. As the firm grows and becomes more profitable, the value of the shares held by employees also increases, ostensibly providing greater retirement income. Studies have shown that employee-owned companies often exhibit higher levels of productivity and innovation. When employees have a direct stake in the firm’s success, they are more likely to contribute ideas, work collaboratively, and strive for excellence.

As a retirement plan, ESOPs offer tax advantages for the company and participating employees. Contributions made to the ESOP are tax-deductible for the employer, and employees typically only pay taxes on the contributions once they withdraw them from the plan. Shareholders who sell to an ESOP can also defer capital gains taxes on the proceeds from the sale if they follow certain requirements.

Most importantly, ESOPs can often facilitate a smoother transition in ownership. Construction firms often face challenges with succession planning, particularly if there aren’t clear options for new leadership. ESOPs provide a mechanism for senior owners to sell all, or a portion, of their stake in the company to employees, ensuring continuity and stability in leadership. It’s also worth noting that—should owners not want to sell entirely into the program—they can determine the percentage of ownership to be sold into an ESOP and that it is possible to sell additional amounts later on down the line.

However, despite the various advantages, ESOPs may still present challenges to an organization. Many of the benefits outlined above depend on the financial health and culture of the organization pursuing an ESOP and will not fit in every case. Determining the fair market value of privately-held company stock, common with ESOPs, can be complex and subjective. Disagreements over valuation may arise between the company, the ESOP trustees, and participants, leading to disputes and uncertainty.

The ESOP essentially purchases the equity from the existing owners and the ESOP and the company must be able to make payments for the purchase of the ownership (either to the owners or to a bank if it was involved in financing the transaction) The company must be financially healthy— generating enough income to ensure these payments will be able to be made. The organizations best suited to implement an ESOP are those with proven financial stability. Moreover, establishing and maintaining an ESOP requires significant administrative efforts and costs. Companies must hire trustees, conduct valuations, provide participant education, and comply with reporting and disclosure requirements.

There are significant compliance requirements with an ESOP. ESOPs are subject to regulatory oversight, including compliance with the Employee Retirement Income Security Act (ERISA) and other federal and state laws. Meeting these regulatory requirements can be time-consuming and costly for the company. Additionally, ESOP trustees will be governed by relevant Department of Labor statutes, subjecting the organization to an added layer of scrutiny and governance. With this added layer, organizations may be limited in discretionary spending in many areas.

When considering an exit strategy, an ESOP is one of many options that should be considered. Each one comes with its own benefits, challenges, and risks. It’s key to utilize a skilled accounting partner to determine if an ESOP is right for your business and steer its implementation.

About the author: Phillip Ross, CPA, CGMA is an Accounting and Audit Partner and Chair of the Construction Industry Group at Anchin, Block & Anchin, LLP. For more construction industry thought leadership and content, log on to www.anchin.com.