Why ESOPs Outperform: Unlocking Value Through Employee Engagement and Tax Savings

Tzortzis Capital
Oct 14, 2024
4 min read

Updated: Dec 10, 2024

Why ESOPs Could Be the Best Move for Your Business

An Employee Stock Ownership Plan (ESOP) offers business owners a unique opportunity to provide employees with an ownership stake in their company. At its core, an ESOP is a benefit plan designed to transition company ownership to its employees, gradually or entirely, through a trust that holds shares for employees. ESOPs have become popular tools for businesses looking to enhance employee engagement, access liquidity, and even facilitate mergers or acquisitions.

The benefits of ESOPs are numerous, but there are three key reasons businesses should consider them for acquisitions or to gain liquidity.

1. Tax Advantages: ESOPs Offer Significant Financial Upside

One of the most compelling reasons for considering an ESOP is the financial benefits, particularly the tax advantages. When a business owner sells to an ESOP, they can defer or completely avoid capital gains taxes if certain conditions are met. This not only creates a smoother transition but allows the seller to maximize the proceeds from the sale. Furthermore, companies that are employee-owned often enjoy tax deductions for contributions to the ESOP, including both stock and cash contributions. These deductions can reduce taxable income and provide the company with valuable liquidity.

In 2023, tax incentives surrounding ESOPs have only grown more attractive. A recent article from ESOP Partners highlights how S corporations that are fully owned by an ESOP can avoid paying federal income tax on their earnings, creating a substantial cash flow advantage that can be reinvested into growth initiatives or acquisitions.

2. Employee Engagement: ESOPs Drive Loyalty and Productivity

Companies with ESOPs often report higher levels of employee engagement, loyalty, and productivity. Why? When employees own a stake in the business, they feel more directly connected to its success. The sense of ownership motivates them to perform at higher levels, knowing their efforts will directly influence the company’s—and by extension, their own—financial health.

A study conducted by the National Center for Employee Ownership (NCEO) revealed that companies with ESOPs tend to outperform their peers in terms of productivity and employee retention. Firms with ESOPs experience sales growth that is approximately 2.4% higher per year compared to non-ESOP companies, and employment growth is about 2.3% higher annually.

Additionally, ESOP companies are more likely to survive economic downturns and maintain stability, further proving the effectiveness of employee ownership in boosting long-term business performance.

For prospective buyers or merger partners, a business with an ESOP in place signals a committed, engaged workforce, reducing the risk of instability post-acquisition and often resulting in higher valuations.

3. Flexible Liquidity Solutions: Transition Ownership Without Losing Control

Perhaps the most significant advantage of an ESOP is the ability to access liquidity without having to sell the business outright. Many business owners use ESOPs as a way to diversify their assets, tap into much-needed liquidity for personal reasons or other ventures, all while retaining management control and ensuring the continuity of their business.

ESOPs allow owners to gradually sell shares to employees over time. This makes it a flexible, low-stress option for business owners who want to ease out of their role but aren’t ready to hand over the reins to an outside buyer. According to a 2023 PitchBook report, more mid-sized companies are turning to ESOPs as a preferred method of liquidity due to the instability in traditional financing markets and rising interest rates.

A Success Story: Rocky Mountain Steel Inc.

At Hansen Family Office, we recently helped Rocky Mountain Steel Inc., a Colorado-based steel fabrication leader founded in 1997, transition to 100% employee ownership through an ESOP. This ESOP has been a game-changer for the company and its employees, demonstrating the immense value of employee ownership. The company’s employees are now more engaged, motivated, and committed to its future growth.

Colorado Governor Jared Polis shared his enthusiasm for the success of Rocky Mountain Steel’s transition to an ESOP, stating:

“Congratulations to the new employee-owners of Rocky Mountain Steel, Inc.! Your hard work contributed to the company’s success, and now you will continue its legacy. I am proud of our administration’s work to save businesses like Rocky Mountain Steel money and support employee ownership so that everyone can benefit when a business thrives.”

Additionally, Dylan Wiman, who led the ESOP transaction, has since been named President of Rocky Mountain Steel Inc., cementing a future of strong leadership and continued excellence for the company. Read the complete release here.

Why ESOPs Are a Good Fit for Today’s Businesses

Given the current economic landscape, where traditional financing methods are becoming more restrictive, ESOPs offer businesses a reliable alternative for accessing liquidity or executing strategic acquisitions. They not only deliver tangible financial benefits but also provide an unmatched tool for fostering long-term employee commitment and performance.

If you’re looking to explore how an ESOP could transform your business, from providing financial flexibility to ensuring the continued legacy of your company, now might be the time to explore this option. We’ve seen firsthand the success of ESOPs with companies like Rocky Mountain Steel, and we’re here to guide you through the process. Let’s work together to ensure that your business—and your employees—thrive well into the future.

Looking for More?

Explore how an ESOP could transform your business, from financial flexibility to ensuring its continued legacy, now is the perfect time to take action. Access more details on our website by clicking the following links: