Employee stock ownership plans offer tax advantages to business owners and incentivize employees to help their company prosper.
But in Colorado Springs, ESOPs are little known and seldom used. According to the Rocky Mountain Employee Ownership Center, there are only about 150 employee-owned firms in the state.
Gov. Jared Polis aims to change that. On April 10, Polis signed an executive order creating a Commission on Employee Ownership to help businesses that want to transition to the ESOP model.
“Increasing employee ownership will help support a strong economy and promote job security in communities across the state,” Polis said. “Supporting employee ownership has been a top goal, and now we are taking the necessary steps to make it a reality.”
The new commission will create a network of technical support for businesses that want to convert to ESOPs; educate businesses and communities on the benefits to companies and communities of employee-owned businesses; and identify barriers to ESOP development and recommend state actions and resources to remove those barriers.
“Increasing the number of employee-owned businesses will help strengthen businesses and increase benefits for employers,” the executive order stated. “Employee-owners tend to have higher wages, greater household wealth and longer job tenure than workers who are not employee-owners. … When employees succeed, businesses succeed, and when businesses succeed, so should employees.”
According to the National Center for Employee Ownership, an ESOP is a type of employee benefit plan under the Employee Retirement Income Security Act.
The company sets up a trust fund and contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, using cash contributions from the company to repay the loan.
Employees are beneficiaries of the trust, and shares in the trust are allocated to individual employee accounts. Employees do not own the stock but own the value of the stock. When they leave the company, vested employees receive their stock, which the company must buy back from them at fair market value.
Participating in an ESOP represents one of the few opportunities employees have to create wealth.
“Everyone does not necessarily have the personality to be an entrepreneur, much less access to capital,” said Halisi Vinson, executive director of the Rocky Mountain Employee Ownership Center, one of seven regional centers affiliated with the national center. “That doesn’t mean they’re not adding value.
“One of the tenets that RMEOC believes is that when you have a stake in the outcome, it leads to better results … and stronger, more resilient companies. Employee-owned companies statistically do better, make more money and have better benefits in the jobs that they work, even for low-income employees,” Vinson said.
Employees in ESOPs earn higher incomes and accumulate more funds in their retirement accounts than in non-ESOP companies.
“The average employee will retire with 2.5 times more in their retirement account than folks that do not work at an employee-owned company,” Vinson said. “If you look at huge companies like Publix Super Markets or WinCo Foods, that are both employee-owned, you’ve got cashiers that will retire with seven figures in their retirement accounts.”
BENEFITS TO EMPLOYERS
The advantages of ESOPs to employers are “specific and so amazing,” said Ron Lint, CEO of ATI Capital Group of Colorado, who has worked with ESOPs since 1991.
ESOPs offer business owners a way to retire while preserving the legacy of the company.
“The [founder, probably the CEO, of a C corporation] selling his or her stock to the ESOP can do it without any capital gains tax,” Lint said. “There’s no other way under the law to do that. State and federal is about 25 percent, depending on the state, so that’s about 25 percent you’re not paying by selling your own company, if it’s a C corporation.”
ESOPs also can exempt some companies from state or federal income tax.
“As an S corporation, to the extent that the company is owned by an ESOP, the earnings of that company are no longer subject to state or federal income tax,” he said. “If an S corporation is 100 percent owned by its ESOP, which is the goal, none of its earnings are subject to state or federal income tax. You can have a tax-free company.”
In addition, ESOPs enable companies to expand.
“You can buy other companies with pretax dollars,” Lint said. “You only need one holding company that has one ESOP, and you can buy 15 companies under it if you wanted to, with pretax dollars. That means every penny, principal and interest, it takes to buy that company is tax-deductible to the parent company. That’s huge.”
Companies also can buy heavy equipment or buildings through the ESOP and deduct the principal and interest.
Lint said a trucking company he worked with in Texas needed to buy $5 million worth of vehicles. After starting an ESOP, the company borrowed $5 million, for which the trucks were collateral. The company then loaned the $5 million to the ESOP, which the ESOP used to buy $5 million worth of new shares.
“That $5 million goes back to the company,” he said. “Now the company buys $5 million worth of trucks. And now the 18-wheelers are deductible, principal and interest. It was huge for that company.”
ESOPs also can help companies in need of operating funds.
“You can decide to roll your money from the 401(k) over to the ESOP and own part of the company, and there’s no tax on that,” Lint said. “Since cash is now inside the ESOP, the trustee can decide to buy more stock in the company and put the cash back into the company. The company then can do what it needs to do to improve its operations with that cash. The people should be allowed to vote for this transaction because the company should not take an employee’s 401(k) fund without their approval.”
The major challenge associated with ESOPs, Lint said, is that companies must set aside funds so that the company can purchase the stock of employees who die, retire, become permanently disabled or quit after becoming fully vested.
“It’s costly, but when you do all the analysis, the ESOP plan vastly overwhelms any other concept,” he said. “You get a repurchase liability study done by an independent actuary, and the company knows exactly what it needs to set aside for repurchase liability. There are ways of lessening that burden for a company. You just need to do it with wisdom.”
There are other forms of employee ownership, such as co-ops and granting of stock appreciation rights, “but none of them have the tax advantages ESOPs have,” Lint said.
When Polis signed the order creating the new commission to encourage ESOPs, he did so at one of Colorado Springs’ two Save-A-Lot stores. They are among 17 stores operated by Franktown-based Leevers Supermarkets, an employee-owned company.
The 81-year-old company was family-owned and -operated for three generations — until 2012, when it was sold to the employees through the creation of an ESOP.
“It was definitely a way to protect the business and all the work that went into building it, and carry it into the future,” said Gabe Disbrow, the company’s COO. “That was front of mind in terms of the decision for the family. It was a way to incentivize everybody with ownership, philosophically change the objective of the business and protect it.”
The switch to employee ownership resulted in remarkable changes.
“It’s definitely a more invested kind of workforce,” Disbrow said. “We’re all working toward the same objectives. It’s something that enables us to create accountability around the same objectives at a higher level. It creates a sense of reward for the employees.”
Brothers John and Chris Leevers, members of the founding family, remain as president and vice president. All other full-time employees are classified as owners or future owners.
Since the creation of the ESOP, “we’ve gone through a phase of rapid expansion and reinvestment in the core business,” Disbrow said. “We’re very active in allocating investments in enhancing some of our existing stores and investing in the communities we serve.”
The company recently remodeled and relaunched its oldest store, the Save-A-Lot store in Pueblo, and has started an initial wave of reinvestment to modernize and upgrade the décor of the store at 405 S. Circle Drive.
It’s important for business owners who want to create an ESOP to consider carefully the pros and cons and to weigh the setup costs, which are substantial, against their goals and objectives.
Setting up an ESOP is “extremely burdensome if you don’t have somebody who knows how to do it,” Lint said.
Vinson of the Rocky Mountain Employee Ownership Center agreed.
“ESOPs are very highly regulated, and you need to hire someone who has done it before, and not just once,” she said. “We have a list of folks in Colorado who specialize in ESOPs, from the legal and financial sides.”
The center helps businesses navigate the system, offers educational workshops and webinars, and works behind the scenes to create a governmental environment conducive to promoting employee ownership.
“To take this to the next level, we really need government support,” Vinson said. The newly created commission “is going to be a think tank, offer suggestions on any further legislation that might be appropriate and really work with the small business development centers. This is going to really help [Polis] create a strategic plan on how we can maintain and save our businesses both rurally and along the Front Range.”
Companies that embrace ESOPs see their culture start to change as employees develop an ownership mentality.
“What we suggest is that you really start teaching employees the business of the business and listen to them when they suggest how their departments can operate more efficiently and effectively,” Vinson said.
“Employees say, ‘I finally do not feel like a number, I feel like I’m adding value that is tangible, and my voice is being heard,’” she said. “I don’t know how you put a price on that.”