ESOPs: Top Five Reasons to Perform a Repurchase Liability Study

Thoughtware Article Published: Sep 17, 2018
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An employee stock ownership plan (ESOP) is designed to invest primarily in the stock of the company that sponsors the plan. In privately held companies, either the ESOP or the plan sponsor is required to purchase a participant’s shares when he or she is eligible to receive a distribution. This cash requirement represents the company’s repurchase liability. An important step in managing and funding the repurchase liability is preparing a repurchase liability study (RLS). In this article, we’ll explore the top five reasons to perform an RLS.

Cash flow management – A repurchase liability can have a significant effect on company cash flow, especially for a mature ESOP that has experienced significant stock growth since the inception of the ESOP. An RLS will help forecast future cash requirements to fund distributions while helping predict the effect the liability will have on future stock price. This is especially important as management balances competing requirements for cash, such as funding working capital, debt service, capital expenditures and company growth. 

Compliance issues – Contributions to all qualified plans are generally limited to 25 percent of eligible payroll on a combined basis. In addition, all employer contributions and employee deferrals into qualified plans can’t exceed the lesser of $55,000* or 100 percent of a participant’s eligible pay in a given year. Significant stock growth and an increase in distributions for mature ESOPs can result in issues with these limitations and ongoing administrative concerns. These concerns can be analyzed and addressed by considering alternate strategies or scenarios as part of the RLS.

Funding requirements – Most new ESOPs operate with a “pay as you go” approach, as distributions in the first few years are usually minimal. Mature ESOPs likely will need to explore other approaches as they deal with significant distributions from the plan once the acquisition loan is fully repaid and substantial account balances become payable. An RLS will help analyze other approaches to funding the repurchase obligation and determine which approach is the right fit for the company.

Benefit levels – The ESOP benefit level is the value participants receive in their ESOP accounts annually from employer contributions and forfeitures. This often is referred to as a “contribution rate” and computed annually as a percentage of eligible payroll. An RLS will analyze the projected benefit levels over the life of the study to help determine the most suitable approach to providing meaningful yet sustainable benefit levels for current and future ESOP participants. Achieving the desired level of employee benefit can help companies retain and attract employees, remain competitive in the marketplace, avoid “have and have-nots” and positively affect turnover.

Sustainability – All of the above items can have a significant effect on the sustainability of both the company and the ESOP. Other items to consider include existing internal loan terms, company demographics and expected stock growth. An RLS will allow the company to analyze these concerns and assist management in determining strategies for viability of the company and ESOP. The ESOP trustee, the company board of directors and the management team all have a vested interest in ensuring the sustainability of the company and plan. 

While there isn’t regulatory guidance on how often a study should be prepared, consideration of the repurchase obligation should be an ongoing assessment. We recommend preparing an RLS every three to four years in general, or more frequently if there’s a material change in the business outlook or participant demographics.

To learn more about how you could benefit from an RLS, contact Ryan or your trusted BKD advisor.

* Amount as of 2018, indexed for inflation

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