Here's a good New Year's Resolution for financial professionals: learn more about employee stock ownership plans. Why? Because if you don't know much about them, you may be missing a unique opportunity—one that could help you unlock millions of dollars in previously unavailable assets, demonstrate your value to high net worth clients and grow your business.
Baby boomers hold a tremendous amount of assets in privately owned businesses. According to a 2010 LIMRA study, the value of business ownership for individuals age 55 to 70 who haven't retired is estimated at $4.8 trillion.
Only one out of seven of these business owners plan to pass their businesses along to family. And nearly nine out of 10 have no exit strategy at all. With nearly 80 percent of their net worth tied to business ownership, these individuals need help converting some of those business assets into investable assets as they approach retirement.
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When appropriate, you can recommend ESOPs to make that happen. ESOPs are great vehicles for helping business owners:
- Unlock previously illiquid assets
- Gain greater diversification
- Develop an exit strategy when they're ready to retire
What is an ESOP?
Let's start with a definition.
An ESOP is a qualified defined contribution retirement plan.
It has two features that make it unique from other qualified retirement plans (such as 401(k), profit sharing, or defined benefit plans):
- It is invested primarily in the stock of the sponsoring corporation
- It can borrow money
These two unique features would be prohibited transactions in other retirement plans. Yet, these are the very features that can make an ESOP a powerful diversification or succession planning approach for many business owners. How an ESOP can diversify a business will be explained in later blogs.
What are some benefits of an ESOP over other qualified retirement plans?
An ESOP allows the owner of a C or S corporation to sell all or part of their company to an ESOP trust on behalf of their employees. The business owner can control:
- The timing and extent of his or her exit from the company
- The day-to-day operation of the company
The unique tax treatment of ESOPs helps fund the sale of the company (more on that in future blogs).
An ESOP has benefits to the company owner, the company, and the employees. Yet few understand these plans and how to take advantage of their unique features.
An ESOP is not a good fit for every business owner or company. An ESOP may not be the best choice if:
(1) The company is too small. In general the value of the business should be at least $5 to $7 million and should have 30 or more employees.
(2) The business is facing challenges with its business model or markets.
(3) The business owner does not distinguish between company and personal finances.
Why should you care?
ESOPs can present significant cross-selling opportunities to financial professionals who bring the idea to business owner clients. ESOPs can generate a sizeable pool of investable assets and additional needs for life insurance and estate planning and perhaps access to the existing defined contribution plan. I will write more about the opportunities in coming months.
Company stock is not a pooled investment. Stock may experience greater volatility and should not be directly compared to investment options that have a more diversified investment mix. It is not intended to serve as a complete investment program by itself.
Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group (The Principal), Des Moines, IA 50392.
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