Employee Stock Ownership Plans (ESOPs) allow companies to cultivate a culture of employee ownership and reward employee owners with attractive retirement benefits. However, when an ESOP company is struggling, terminating the ESOP may be the only viable option.
Terminating an ESOP plan isn’t ideal for a number of reasons, but when it’s necessary, all information — positive and negative — must be weighed and factored into the decision. The implications of an ESOP termination may be significant for the company and employees.
Situations when ESOP termination may be the best option
ESOP plan termination isn’t a decision that’s easily made, but there are compelling reasons for a company to take the step:
- Financial limitations that prohibit the company from paying administrative expenses, making contributions, and otherwise maintaining the ESOP
- Plan maturity that signals the conditions of a structured ESOP plan have been met, such as reaching a duration end date or meeting specific goals
- Revised business objectives that shift the company away from employee ownership, and/or change retirement benefits
- Company sale or merger which commonly results in ending ESOP benefits
- Company closure which necessitates plan termination and distribution of assets among employees
Potential advantages of an ESOP plan termination
When aligned with the reason for doing it, there are strategic advantages to ending an ESOP:
- Streamlined corporate ownership structure that could simplify management practices
- Fewer administrative obligations since ending an ESOP also ends required plan reporting, valuation, compliance oversight, and other related tasks
- More strategic flexibility to pursue restructuring, debt reconfiguration, and other corporate initiatives
- Resources reallocation that funnel funds previously used in the ESOP to other business priorities
Potential disadvantages of an ESOP plan termination
Winding down an ESOP brings with it complexities that need to be considered — and navigated. Careful consideration should be given to the potential downsides of ending a plan, including:
- Loss of tax benefits extended specifically to ESOPs
- Potential loss of competitive advantage in hiring and retention since ESOPs are a sought-after benefit in the job market
- Shift in employee morale and motivation that were previously enhanced by employee ownership
- Complex and often expensive wind-down process that can tie up legal, financial, and administrative resources
- Possible fiduciary, distribution, and tax issues if the termination isn’t managed properly
Communications: Supporting Employees and the Ownership Culture
ESOP companies are built on employee ownership and ownership culture. When an ESOP is ended, the impact can understandably cause confusion and lower morale among employees, and possibly higher turnover rates. The culture could suffer, fueling rumors and assumptions.
Transparency is critical, and it starts with an effective communication strategy that spells out the reasons behind the decision, and the implications for employee owners.
Developing a communication strategy that includes these 6 action steps addresses participant concerns while also helping make them feel empowered and valued during the transition:
- Develop a clear message that serves as the basis for all communications, and concisely conveys the reasons behind the ESOP termination to employees.
- Make a company-wide announcement — such as in a meeting or town hall discussion — to ensure the same information is delivered to all employees simultaneously, thereby avoiding confusion and opening lines of honest, transparent communication.
- Capture the details of the plan termination in writing so employees have reference materials that explain the process, potential financial consequences, timelines, and other pertinent FAQ-type information.
- Arrange for company-sponsored financial counseling sessions to help employees realign their financial goals with the impacts of the termination.
- Provide one-on-one meetings between management and employees so situation-specific situations and questions can be addressed privately to alleviate anxiety and miscommunication.
- Discuss how the company will move forward, and how employees will be integral to achieving broader, future business goals — a message that could buoy morale and encourage continued engagement and effort.
How an ESOP consultant strengthens communication
Working with an ESOP consultant to round out a communication strategy is a failsafe and a trustbuilder. Their specialized expertise is instrumental in explaining more granular plan details, and taking action to support the larger communication strategy, such as:
- Guiding key messaging around timelines, impacts, and appropriate responses to commonly asked questions
- Identifying the best communication channels — emails, group and/or individual meetings, intranet updates, etc. — and how to use them to facilitate ongoing, open communication
- Helping manage communication flow, proper sequencing, and receipt of consistent information by participants, leadership, trustees, and other stakeholders
- Developing accessible resources to educate and inform participants about the termination process, such as FAQ sheets, guides, and other similar content
- Overseeing regulatory and legal compliance of communications, primarily those dealing with participant notification of plan changes and/or their individual rights
Why involving an ESOP consultant early in plan termination is crucial
Waiting until the communication phase to involve an ESOP consultant in an ESOP plan termination limits the value derived from the partnership.
Early involvement provides opportunities for consultants to apply their financial, legal, and administrative expertise to the wind-down process, which can prevent costly errors and make the transition as seamless as possible.
In addition to participant communications and engagement, an ESOP consultant comes alongside ESOP company decision makers to manage:
- Coordination of the activities of the company, trustee, counsel, and other advisors as they relate to the ESOP termination
- Recordkeeping related to termination specifics including interim allocations, distribution election, IRS and ERISA reporting, participant and beneficiary verification, and statement preparation
- Fiduciary responsibilities that encompass advising on issues faced by the trustee, and following ERISA obligations
- Regulatory and legal compliance so all legislative rules and documentation requirements are accurately followed and applied to the termination
- Valuation and fairness opinions with the help of the ESOP trustee to ensure participants are receiving fair share value, and that the terms of the termination are equitable for all stakeholders
- Benefits distribution to participants, and related vesting schedules and adjustments
- Transaction assistance should the ESOP termination be part of a sale or merger/acquisition
ESOP termination is both impactful and unique to every company. Pursuing a wind-down can be daunting without proper planning and an ESOP expert at your side to help.
As ESOP specialists, ESOP Partners is an ideal fit to handle all aspects of this complex and often delicate process, so you can be confident in your decision and the evolution of future-focused business strategies. Contact the ESOP Partners team to discuss your needs and how we align with them.
