Corey Rosen, Director
The National Center for Employee Ownership
One of the most frequently asked questions we receive at the National Center for Employee Ownership is “Am I too small to have an ESOP?” There is no simple answer. There are, however, some basic guidelines that can help determine whether an ESOP is worthwhile.
First, of course, you must know how much an ESOP will cost. Unfortunately, cost estimates vary widely from one case to another and one consultant to another. There are several components of cost-preparing plan documents and government filings; obtaining a valuation; administration; and, in a leveraged ESOP, loan commitment fees, legal fees for the lender’s counsel and loan documents; and, possibly, financial consulting for structuring the transaction.
The cost of drawing up the plan documents and government filings is generally not as much as people think it will be. In a small company transaction, legal fees of $25,000 to $40,000 are typical. These costs will be somewhat lower if you come well prepared, already understanding the basics of ESOP rules, and knowing what you want your plan to do. Most ESOP attorneys have plan document templates in their word processing systems. Their fees are largely a function of the time they spend with you figuring out what the document should include.
Valuation normally will carry fees in the range of $8,000 - 10,000 for smaller companies, assuming there is only one class of stock in the company and no unusual complicating elements. Repeat annual valuations should be less. It may be possible to obtain an even lower fee in some cases, but it is imperative that costs not be cut by hiring people who do not normally do ESOP work.
Plan administration costs (e.g., keeping records, filing reports, and sending plan account statements) depend on the number of employees. There are certain fixed costs, however, so there are some economies of scale for larger companies. A company of 20 employees might reasonably expect to pay around $2,000 per year in administration fees.
Costs become really high when an ESOP borrows money. The lender usually wants legal opinions from its counsel and charges loan commitment fees involved in a mortgage transaction. Even in a transaction of several hundred thousand dollars, this could add another $10,000 to the costs. If a loan cannot easily be obtained, or if the transaction involves multiple sources of financing, it may be necessary to hire a financial adviser to help structure the deal. These experts often charge a percentage of the transaction costs, typically 1% to 3%, with the percentage being a function of the size of the transaction.
All of these estimates should be viewed cautiously. Invariably, when we report costs we receive at least a few complaints that we misled people. Some say our estimates are much too high; some say much too low. The truth is that costs vary considerably depending on the nature of the transaction. The costs listed here are “ballpark” number for simple transactions.
Assessing Costs Versus Benefits
There are several things to consider when trying to figure out if these costs can be justified:
What Are the Alternatives? It will probably cost $50,000 or more for a leveraged ESOP to buy out part or all of an owner’s interest in a 20-employee company. That may seem exorbitant in, say, an $800,000 sale. But what are the choices? If the company is sold by a business broker, the percentage of the fee charged will be more than that. If a partial interest is for sale, it may be difficult or impossible to find another buyer willing to offer a reasonable price, adequate security, or a satisfactory continuing employment relationship if the seller wants to stay with the company. Employers also may have a strong preference to have employees own the company.
What is Your Tax Bracket? If you are not paying taxes or are in a low tax bracket, some tax advantages may have little application, although the rollover benefits may still be worthwhile to the seller.
Is Your Payroll Adequate? Figure out what the eligible payroll of the people actually in your plan will be (exclude pay of people who will not qualify for participation or an individual’s pay of over $170,000 a year). Then multiply that by 25%. In a leveraged plan, multiplying this will give you an estimate of the annual amount you can repay on the funds you borrow. Is this going to be enough of an annual contribution to buy as much stock as you want to make available?
As a rule of thumb, ESOPs work best for companies with over 20 employees, but a little back-of-the-envelope calculating using the above formulas can give you a much better idea of whether you are too small.
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