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Employee Stock Ownership Plans were around a long time before Plastics News started in 1989 — they were given statutory authority in 1974. In the 25 years Plastics News has published, numerous plastics companies have set up ESOP plans and reaped the benefits.
The plans are becoming increasingly common as more small and medium size business owners enter retirement age and see ESOPs as a responsible, financially efficient way to exit the firms they founded.
An ESOP is a retirement plan in which the company contributes its stock, or money to buy its stock, to the ESOP plan for the benefit of the company’s employees, according to a definition by the U.S. Department of Labor. Within an ESOP, an employee does not hold stock directly while still employed with the company. An employee is entitled to the stock when the employee retires, is terminated, becomes disabled or dies, at which time the ESOP distributes the shares into the employee’s account.
Worker involvement and heightened commitment to a company are natural benefits of ESOPs. For example, injection and compression molder Dimco-Gray Co. faced a possible breakup in 1986. Workers put their own money up to create a fully leveraged, 100 percent ESOP to save the firm. Initially, the transition was difficult. Profit fell, capital declined, the union fought with management and all the assets were used as collateral. Employees had to learn to cope with their new responsibilities of ownership and financial obligations.
But Dimco-Gray employees eventually were vindicated. The revived company had its most profitable years to date in 1993 and 1994. Sales had grown more than 25 percent in the five years ended in 1994. Employees took more of an interest in the company as they shared more decision making. Absenteeism, late shipments and customer returns all declined.
The upcoming retirement of majority owner Dan Gray sparked the ESOP project at Dimco-Gray. His retirement could have led to a split-up of the company and a sell-off of its operations. The ESOP preserved the company and its core businesses.
An owner’s retirement often spurs implementation of an ESOP. ESOPs are primarily used to transition a business when the owner has no obvious successor and wants to keep the corporate legacy going. Probably 80 percent of ESOPs stem from business transition, estimates Corey Rosen, senior staff member of the National Center for Employee Ownership in Oakland, Calif.
Advantages to a business owner include a tax-favorable way of turning their equity in the business into cash for retirement or other purposes. Employees gain because an ESOP is a kind of employee benefit plan funded by the employer.
Company metrics could improve with an ESOP, according to research cited by NCEO. One study found companies’ sales, employment and productivity grew more than 2 percent faster per year after they instituted ESOPs compared with their pre-ESOP performance.
The sale of shares into an ESOP can be all at once or gradual, for as much stock as desired.
Tubing manufacturer NewAge Industries Inc. recently boosted its ESOP ownership to 40 percent from 30 percent. The plan, which began in 2006, convinced employees to take more interest in how well the business fares, a retired employee said.
If a company has an effective and dedicated staff the transition to an ESOP can be smooth. Custom injection molder PTA Corp. instituted an ESOP in 2011 when Chairman and President Ray Seeley sold his shares to an ESOP trust. Employees had been groomed to run the company. Seeley rewarded the employees for their service rather than sell the company to an outsider for perhaps more personal gain. Less than a year after the ESOP startup, PTA was healthy enough to plan expansions at its two facilities.
ESOPs are not a panacea, however, according to NCEO. A company should have 15 to 20 employees and be profitable enough to buy out an owner. Management continuity should be assured so that banks, suppliers and customers can be confident the business will operate successfully. Employers can’t cherry-pick and offer the ESOP to only favorite employees. Legal and other costs in setting up an ESOP can be steep.
Another risk is the possibility of a capital shortage within the company. A company is obligated to buy back stock from departing employees. If buyback is not factored realistically in the valuation of the ESOP plan, it could cause a capital shortage. As well, when an ESOP takes on debt to buy out an owner, it devotes a significant amount of money to the repayment, often over a period of 5 to 7 years.
Custom injection molder Nypro Inc. set up an ESOP in 1998 but over time found it impeded the ability to amass capital Nypro wanted for investing to fend off global competition. By the time Jabil Circuit Inc. bought the company in 2013, longtime Nypro Chairman Gordon Lankton owned only 1 percent of the firm. Its ESOP participants did well — Jabil paid $665 million for Nypro, owned by 1,900 employees in an ESOP and 200 international employees not included in the plan.
Prior to the sale to Jabil, Nypro’s contributions to the ESOP and the resultant capital constraint was a drawback that Lankton did not foresee clearly when Nypro first set up its ESOP. Of course, non-ESOP companies too can have capital constraint problems.
Coren of NCEO estimates about 30,000 U.S. manufacturing companies with owners older than 50 years qualify as ESOP candidates and that about 5 percent of those companies have ESOPs. Lack of data more than 15 years old makes it hard to compare how many manufacturers, let alone plastics firms, had ESOPs at Plastics News’ inauguration in 1989, but Coren believes the current level is higher than it was then.
U.S. boomers who have recently retired or are reaching retirement age are fueling more interest in ESOPs among closely held corporations. The youngest boomers are entering their 50s, promising continued ESOP growth. More plastic business owners could find an ESOP an attractive, tax-favorable way of exiting a business. Continuing companies with corporate S status would have tax advantages that help them accumulate internal capital which they can use to buy out a competitor or expand.