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.