Mutual Benefits An employee stock ownership plan lets you take some cash out of your company while giving your workers a stake in the business.

Thanks to the media hype surrounding United Airlines'blockbuster bankruptcy in 2002, employee stock ownership plans gota reputation for being mainly a big-business tool. The troubledparent company of United was partially owned by an ESOP until itfiled Chapter 11. But ESOPs are far more common at companies with$20 million to $50 million in revenue, says J. Michael Keeling,president of The ESOP Association in Washington, DC. "When onebig company like United Airlines gets involved with an ESOP,"he says, "the impression is [that only big companies are]doing them. But that's not correct."

For the BIZ Experiences who wants to start getting liquidity out ofhis or her company in anticipation of a transition, but doesn'twant to sell and risk the displacement of employees and the loss ofa legacy, an ESOP is worth a look. In addition to giving workersanother incentive to do their best, ESOPs offer lucrative taxbenefits for both the company and its owners. Contributions to theplan are tax-deductible, and S corporations don't pay federaltaxes on the percentage of earnings owned by the ESOP. Also, a Ccorporation owner selling at least 30 percent can defer payingcapital gains tax on the proceeds, as long as they're investedin other U.S. companies' securities. "There are no otherways a company can use its own funds to buy out an owner on apretax basis," notes Corey Rosen, co-founder and executivedirector of the National Center for Employee Ownership in Oakland,California.

The tax benefit was a big draw for Maryland Office Interiors, a23-year-old Baltimore company that set up an ESOP in 2001. Theowners didn't want to sell outright and weren't thrilledabout the idea of bringing in VCs. "[VCs'] valuations area little more aggressive, but their expectations for growth are alot more aggressive," says company president David Noel, 44,who oversaw the setup of the ESOP plan, which began with a 30percent allocation.

Setting up an ESOP is also a way to cash out gradually,maintaining full control of the company for as long as you want,notes Keeling. "You can begin to get liquid and diversify yourassets, and still be CEO of the company," he says."Lenders love to hear that because most of these companies arehealthy, and they want to hear the same leadership is going to bethere."

Getting bank approval is significant because companies typicallyhave to borrow to fund the first ESOP transaction. There are waysaround that, though. When M. Nelson Barnes & Sons Inc. decidedto set up an ESOP, the Cockeysville, Maryland, contractor chose tofund the trust account for four years prior to the first stockpurchase for 30 percent of shares. "Historically, we had nevercarried a lot of debt, and we wanted to keep the balance sheetclean," says CFO Greg McGowan, who adds that as of March, thecompany is 100 percent employee-owned.

There are other challenges besides debt, to be sure. An ESOPwill be a greater administrative burden for the CFO and willrequire an independent valuation every year. The company also mustbe able to shoulder its repurchase obligations in the future, whenvested employees leave, die, are disabled or retire. "Even at35 percent, that [amount] can get very large and become a drag oncapital investments," says Keeling.

The National Center for Employee Ownership recommends that allcompanies do a feasibility study, either with a simple businessplan in-house or with an outside consultant, such as Morristown,New Jersey-based SES Advisors. Although costs vary by size andcomplexity, expect to pay about $50,000 to $60,000 to set up theplan, Rosen estimates. "That seems like a lot compared to aprofit-sharing plan--and it is," he says, but not necessarilywhen compared to selling the business, if that's the ultimategoal. "It's tough to sell a business [spending] less than10 percent of its value. With an ESOP, it's a fixedamount." And while you're at it, you get a retentionvehicle that makes employees feel like part of the family.