Masonry Magazine August 1994 Page. 11

Masonry Magazine August 1994 Page. 11

Masonry Magazine August 1994 Page. 11
Nineteen Reasons Not To Do It

ESOPs for Contractors?

Having job security and retirement security built totally on a construction business is a questionable decision.

HUGH RICE
Senior Vice President, and
GEORGE REDDIN
Senior Consultant
FMI Corporation

ARE YOU considering an Employee Stock Ownership Plan (ESOP) for your construction firm? If so, resist the temptation. Everyone knows about the advantages of ESOPs, such as pretax stock purchase, tax free rollover, bank tax reduction and deductible dividends.

These advantages are powerful and convincing reasons to install an ESOP. But since 99 percent of those of you reading this article do not work for ESOP-owned companies, there must be some compelling reasons not to make use of this vehicle.

Let's consider some of the disadvantages.

1. No Discrimination-All employees who are not members of a collective bargaining unit and who have worked 1,000 hours or more must be allowed to participate in the plan. A select group of employees cannot be the only plan participants.

2. Independent Appraisal The law requires transactions with an ESOP to be based on the fair market value of the stock, as determined by an independent appraiser. Even if the appraisal is too high or too low, you must still use it. Also, stock transactions outside of the ESOP must be conducted at the appraised value.

3. Employee Put Option Exiting employees may require the company to buy back their shares. This repurchase obligation is a very real off-the-balance-sheet liability of the company.

4. Participant Account Diversification-Plan participants have the right to diversify 25 percent of their accounts at age 55, and 50 percent at age 60, out of employee stock and into less risky investments. This option requires that liquidity be maintained in the plan to meet these requests.

5. Retirement Funds at Risk-One of the philosophical dilemmas of an ESOP is the investment risk versus reward. While having the employees invest directly in their employer has great appeal, the reverse side of the coin is the risk of the employees losing their retirement assets if the company fails. Having job security and retirement security built totally on a construction business is a questionable decision.

6. Volatility of Earnings-Construction companies have wide swings in earnings-and, not infrequently, unprofitable years. These earning swings create fluctuations in stock value, which can be problematic for participants. Also, if losses are sustained, the tax deductibility of the contributions is of no value.

7. Surety Companies' Posture-Since bonding credit is the lifeblood of most construction firms, keeping the surety happy is paramount. Sureties look with disfavor on ESOPs because of the funding requirements, repurchase obligation, and frequent absence of a major shareholder to provide personal guarantees.

8. ESOP Debt-If the ESOP is leveraged to gain some of the advantages mentioned above, then the debt goes on the company's balance sheet-since the company is the guarantor and ultimate source of repayment of the debt.

9. Government Scrutiny-The IRS and Department of Labor closely review and monitor all ESOPs to determine if they are being operated in the best interests of the employee participants. This review and the reporting requirements can be time consuming and expensive.

10. Pass Through Voting Rights-Even though the trustee votes the ESOP shares on most issues, the vote must be passed through to the plan participants on any items requiring more than a majority vote of the shareholders. These typically include such items as merger, sale, or liquidation.

11. Not "Real" Stockholders-Because the employees are not allowed to own actual stock certificates or to vote the stock, they may resent efforts to motivate them to "act like owners."

12. Losses Create Reverse Leverage-ESOPs tend to work well if profits are regular and increasing. However, losses create several negatives. An absence of profits means no tax deductions and no cash to repay loans or meet repurchase obligations. Losses will usually create the need for employee terminations, which trigger stock repurchases-thus caus-

Is an ESOP the right vehicle for your construction firm? For 98 of 100 contractors, the answer is clearly no. For the other two, it may be the only viable solution. Do not, however, allow yourself to be "sold" an ESOP. In this area, healthy skepticism is the appropriate response.


Masonry Magazine December 2012 Page. 45
December 2012

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Masonry Magazine December 2012 Page. 46
December 2012

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Masonry Magazine December 2012 Page. 47
December 2012

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