How Your Company Could Benefit from Employee Stock Ownership

Have you ever considered how an employee stock ownership plan (ESOP) could work for your construction company? There are a number of reasons to consider this course of action, the first being an exit strategy for one or more of your owners.

Understanding an ESOP

An ESOP is an intriguing employee benefit plan that allows employees to have ownership of part or all of the company that employs them. ESOPs are most commonly used to facilitate succession planning, enabling a company owner to sell shares and effectively transition from the business.

When owners of a construction company are ready to leave or retire, they may hesitate to sell to a competitor. In addition, in many cases, private equity companies may not be interested in investing in construction businesses. For these and other reasons, an ESOP can be a prudent choice.

A company creates an ESOP by setting up a trust. The company can then add cash to that trust to buy shares from an owner at a price that is not higher than market value. However, if the owner does not want to sell shares, the company can issue new ones. (If the company cannot afford to purchase or issue shares initially, they can secure a loan to do so.) Shares in the trust are then distributed to employees, often based on their rate of pay. As they continue to work for the company, employees see their right to shares increase. Eventually, employees will own the business, which includes having voting rights and other levels of control. When employees leave or retire, they receive their shares, which the company then pays them for.

Before engaging in the ESOP process, a company should obtain a feasibility study. That will look at valuation, financing, and ultimate benefits for employees. Companies should also consider future management transition issues and long-term goals. 

Special Consideration: Surety Bonds

As you undoubtedly know, construction companies are generally required to obtain surety bonds that ensure a contractor’s compliance with the contract. Sureties guarantee a project owner that the contractor is financially and professionally sound. Before issuing a surety bond, surety companies conduct a thorough underwriting review. This review looks at the contractor’s experience, staff structure, and financial condition, often focusing on the company’s working capital and net worth.

A company with existing surety bonds may face restrictions in incurring debt, so it may need to discuss a potential ESOP plan with the surety company. Such discussions can be time-consuming and may require the assistance of financial professionals familiar with ESOP details.

Advantages of an ESOP

· Tax status: In addition to offering an option for succession planning, an ESOP has many tax advantages. For example, if a company does secure a loan for initial shares, those loan payments may be tax deductible. In addition, a shareholder of a C-corporation who sells shares may allowed to defer the associated capital gains. Also, for companies with S-corporation status, the ESOP’s share of recognized earnings is usually exempt from income taxes. When a company becomes an entirely ESOP-owned S-corporation, it will have the optimal tax status.

· Employee morale: An ESOP can provide employees with a sense of ownership, which motivates them to perform at an even higher level and increases the company’s stock value. An ESOP can become an incentive for employee retention, encourage long-term growth, and perhaps even reduce interest in unions.

· Cash flow: A company with an ESOP may see increased cash flow in the form of reduced corporate income taxes. In addition, if the ESOP replaces contributions to a 401(k) or another employee retirement plan, the company can use those funds for future projects and growth instead.

· Consistency: When a company owner is ready to retire, there is often no continuity plan in place. However, with an ESOP, a company can maintain consistency through employee ownership.

Final Advice

If your company will be facing a leadership change in the near future or if you are an owner ready to step down soon, you might benefit from an ESOP. Take the time to review your unique situation and see if an ESOP is right for you.

Author’s note: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.

About the author: Trent Cotney is a partner and Construction Practice Group Leader at the law firm of Adams and Reese LLP and NRCA General Counsel. For more information, call (866) 303-5868 or email [email protected].