The Proactive Solutions Blog

Constructing a Construction Company Future with Employees as Owners through an ESOP

Posted by on 07.12.16

The difference between company ownership and employment is being recognized by a growing number of construction companies, which are finding it increasingly beneficial financially and operationally to convert to ESOPs (Employee Stock Ownership Plans).

In addition to the potential profit and tax savings, employees-as-owners can have a different set of priorities than employees-as-workers only:

  • Motivation: their success is tied directly to the company’s, and vice-versa.
  • Involvement: sometimes a statement by a company that its employees are “committed” to their jobs is just words strung together; however, when employees are the owners, they’re committed.
  • Invested (other than just in money): employee owners are less likely to allow sloth, sloppiness, or small or large wrongdoing by others in the company.
  • Loyal: when someone is an owner that person is more likely to stay within the fold rather than jump the fence for the hope of greener pastures

In Aug. 2015, the National Center for Employee Ownership’s list of top 100 employee-owned companies listed eight as purely in construction.  Three others, including the No. 2 listed company, CH2M Hill, are described as engineering and construction.  Another 18 ESOP companies are engaged in construction-related activities, from architects and engineering to air conditioner manufacturing.

The NCEO says that,

“As of 2015, we at the National Center for Employee Ownership (NCEO) estimate there are roughly 7,000 employee stock ownership plans (ESOPs) covering about 13.5 million employees.”

And, as shared, a growing number are construction or construction-related companies. An ESOP can also be described as a form of profit-sharing or as a retirement program with specific tax advantages.  An ESOP is a trust fund into which the company can:

  • Borrow money under the ESOP to purchase shares in the company (repaid by the company)
  • Put cash into the fund to buy stock
  • Contribute company shares into the trust fund

The overarching advantage is that whatever the contribution, in whatever form, is (within IRS guidelines) tax deductible.

Employees are participants in the plan either through pay rates, years of service, or some other approved formula for participation. The longer an employee is employed by the company the greater their participation in the ESOP. Under ESOP rules, an employee is fully vested in the program as early as three years, or as long as six years. There are varying rules on ESOPs and depending on whether a company is public or private.

From a tax standpoint, all taxable income of a 100 percent employee-owned S-Corp. goes through to the ESOP, which serves as the single shareholder. As a recognized retirement program (under IRS Section 401a), the ESOP’s income is tax-exempt.

Here’s what the NCEO identifies as the three top advantages of an ESOP:

1.       “To buy the shares of a departing owner: Owners of privately held companies can use an ESOP to create a ready market for their shares. Under this approach, the company can make tax-deductible cash contributions to the ESOP to buy out an owner’s shares, or it can have the ESOP borrow money to buy the shares (see below).

2.       “To borrow money at a lower after-tax cost: ESOPs are unique among benefit plans in their ability to borrow money. The ESOP borrows cash, which it uses to buy company shares or shares of existing owners. The company then makes tax-deductible contributions to the ESOP to repay the loan, meaning both principal and interest are deductible.

3.       “To create an additional employee benefit: A company can simply issue new or treasury shares to an ESOP, deducting their value (for up to 25% of covered pay) from taxable income. Or a company can contribute cash, buying shares from existing public or private owners. In public companies, which account for about 5% of the plans and about 40% of the plan participants, ESOPs are often used in conjunction with employee savings plans. Rather than matching employee savings with cash, the company will match them with stock from an ESOP, often at a higher matching level.”

If you think an ESOP might be an advantage for you and your employees, seek out advice from experts in the field. It’s not something to enter into without understanding all the ramifications as it’s a fundamental reconstruction of corporate governance and participation.

But it’s paying off handsomely.  A sense of ownership is a motivator, and ownership confers both tax and sales advantages. It’s something at which construction companies should look, and seek the best possible advice. It could be a way to build a better future on a stronger foundation of employee commitment.

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