Having taken advantage of the presentations at last week’s
annual ESOP Association conference, we thought we’d share some additional
thoughts we had about ESOPs. There’s not
much to say about the conference itself.
It was well-run, the material was relevant and useful, even
valuable. There was just enough good
humor and entertainment to help get across material that, frankly, can get a
little esoteric at times.
It struck us, however, that some of the issues addressed (at
least in the technical sessions that we attended) should have added a
dimension. Take, for instance, the issue
of cash management.
The presenters quite properly focused on managing cash as it
relates to an expense of the company.
The ESOP is, after all, a “qualified benefit plan” under law. For accounting purposes it must be treated as
any other business expense.
This raises a related issue, that we raised in last week’s
News from the Network, i.e., the
current move to take away the deductibility of dividends paid into an
ESOP. As we said last week, this is
rather blatantly a way of making worker ownership in general, and ESOPs in
particular, less attractive. It’s also
directly contrary to common sense.
Whether you call it a “company contribution,” “profit sharing,”
“dividend,” or anything else, it must be treated as compensation for accounting
purposes — and compensation is a legitimate business expense and thus
deductible from taxable income.
The point we’re looking at now, however, is that, legally an
ESOP is an employee benefit program and must be treated as such on the books of
the company. Thus dividends paid to the
ESOP should be deductible, the same as any other business expense. For planning purposes, however, management
should regard the ESOP as an ownership vehicle.
It’s a little like when a company asserts, “Our people are
our single greatest resource,” or words to that effect. Everybody knows full well that people are
persons, not things. They are not “resources,”
“human capital,” or any other dehumanizing label. Nevertheless, the company is paying for their
labor, and in a sense has to regard
people as workers the same way it does every other expense item.
A company must never forget, however, that workers are not
only “labor,” but people. As ESOP
Participants, they are also, in a limited legal sense, owners, and thus
partners, not hirelings. (An ESOP
Participant is not a “real” owner, but a “beneficial owner.” The ESOP Trust is the owner of the company.)
Understanding ESOP Participants as owners gives us a whole
different perspective on how, for example, to treat the “Repurchase
Obligation.” The “RO” is, technically, a
contingent liability of the company. As
an employee benefit expense, a good manager will minimize that expense as he or
she is obliged to do. The company is run
for the benefit of its owners, and the owners have the right to expect that
management will optimize return to the owners over the long run.
So management is, in a sense, caught in a Catch-22
situation. As good managers, they must
minimize expenses, even employee benefits when they themselves are
employees. At the same time, those same
employees are the owners for whose benefit the employee benefit expense is
being minimized!
There is, however, a way out. ESOP Participants are, in a very real sense,
partners in the business. Partnerships
often have a Repurchase Obligation — partnership shares usually have to be
bought out. For this purpose, a
partnership will usually build up a cash pool to be able to purchase the share
of a partner who leaves to preclude the sale of the share to someone else, or
to have a partner continue his or her financial interest in a firm that no
longer interests him or her professionally or personally, or for any number of
other reasons, all of them good.
Regarding ESOP Participants as partners changes the whole
scenario with respect to cash management.
Where before the goal was to keep an expense to a minimum, it now
changes to maximize the return to the owners for whose ultimate benefit the
company exists.
It’s a whole new ball game.
#30#
