Chief financial officers have a responsibility to optimize capital efficiency and protect the integrity of the balance sheet. Some, though, overlook the risks their employee stock ownership plans pose to those goals, or they miss financial opportunities by failing to plan for their repurchase liabilities.
ESOPs provide private company owners and stockholders real advantages when making the transition to successor owners. Forming an ESOP creates a market for the stock by selling a portion or all of the company to the plan. It also provides significant tax and liquidity advantages for the shareholders. In addition, the ESOP creates incentives for employees who participate. Corporate ownership through the ESOP trust gives employees a keen interest in the overall performance of the company and increasing the company's share value. Increased share value translates to larger retirement account balances, improved morale and better retention.
ESOP sponsorship brings with it unique responsibilities. In order to assure employees of the ESOP's financial viability, the corporate finance team must develop a plan to fund the plan's repurchase liabilities.
Most private companies begin this process by conducting a comprehensive actuarial repurchase obligation study, examining the employee population and forecasting the company's obligation.
The study considers four factors: retirement, death or disability, termination and diversification.
When vested participants retire, die, become disabled, are terminated from employment, or when certain participants reach age 55, the ESOP's repurchase obligation is triggered. Internal Revenue Code section 409(h) provides that a vested participant who is eligible for a distribution must be given a “put option” enabling him or her to sell shares back to the company. The put option can be triggered with as little as 60 days' notice. In other words, the company must make a market for the company stock held in the participant's account. The RPL is off balance sheet. The company has a real obligation to purchase the shares; however, they are not required to account for this liability on their financial statements.