Employee stock ownership plans incentivize employees and come with significant tax benefits.

ESOPs incentivize employees and come with significant tax benefits.

The Mills James headquarters off Fishinger Boulevard in Columbus is buzzing with employees who seem intent on making the most of their day. They step quickly as they head for the meeting rooms, sound stages, audio studios, editing suites and engineering and control facilities where the creative media company tries to make magic happen for its advertising, broadcast and corporate clients.

A client-first mentality has always been part of the Mills James culture, says Senior Audio Engineer Chip Houze, who has been with the company for 20 years. But he is convinced the outlook on client service has taken on new meaning and importance for employees since founders Ken Mills and Cameron James decided nine years ago that an employee stock ownership plan was the best strategy for their company's long-term future.

The transition was completed last year when Mills and James sold the remainder of their stock to the company's ESOP. The two continue to lead the business-James as CEO and Mills as president-but now as employee-owners just like Houze and others at the 160-person firm.

"When you know you are the owner," Houze says, "your work becomes more meaningful. You say, 'Now this client means so much more to me.' We have control in looking at how we grow the company. There are tons of smart people here who actually talk about that when they go to lunch or are in a meeting."

Employee ownership allows everyone at Mills James to feel the entrepreneurial spirit and motivates them to do their best to ensure the growth of the company, says Laurie Dougherty, an account service specialist who chairs the company's ESOP committee.

"You just don't come in and do your job," she says. "What you do impacts the whole company and the stake you have in it."

James says that's exactly what he and Mills had in mind when they decided an ESOP was the best option for transitioning ownership of their company.

"Everyone here is the product and the brand," James says. "Their talent and ability made us successful over the years. They are an amazing group of people and deserve to be in on the action if we can grow it…An ESOP allows you to be compensated for the value you created (as the owner) and reward your people in the future for the value they create. It makes a lot of sense."

That seems to be supported by the fact that about 7,000 companies have ESOPs covering 13.5 million employees, according to the National Center for Employee Ownership in Oakland, Calif. NCEO says ESOPs are most commonly used to provide a market for the shares of owners of successful closely held companies, motivate and reward employees and take advantage of incentives to borrow money for acquiring new assets in pretax dollars.

So how does it work? NCEO says an ESOP is an employee benefit plan similar in some ways to a profit-sharing plan. The company establishes a trust fund into which it contributes new shares of its own stock or cash to buy existing shares. Alternately, an ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to repay the loan. In both cases, company contributions to the trust are tax-deductible within certain limits.

NCEO says shares in the trust are allocated to individual employee accounts based on pay level or some other formula. Employees become 100 percent vested in the plan within three to six years. They receive their stock at fair market value when they leave the company.

ESOPs also come with significant tax benefits. For example, company contributions used to repay a loan taken out by the ESOP to buy company shares are tax-deductible. In addition, in S corporations, the percentage of ownership held by the ESOP is not subject to federal income tax. Also, employees pay no tax on the company contributions to the ESOP, only on the distribution of their accounts when they retire or leave the company and then at potentially favorable tax rates.

ESOPs are the "Michael Jordan of pensions" because they can do things other pension plans can't, says Columbus attorney Tim Jochim, whose practice at Schatz Brown Glassman LLP focuses on helping companies with ESOPs.

Jochim says no other pension plan can borrow money to buy stock, provide business owners with a tax-free sale and, in the case of S corporations, an exemption on federal income taxes.

"That's huge," he says, "but that's not the reason to do an ESOP-that's just the incentive. The reason is the long-term benefits to employees of the company, the community and the economy."

While a vocal proponent of ESOPs, Jochim says they are not for every company looking to sell. He advises clients to consider all their options, including a sale to an outside buyer, ownership transfer to family members and a management buyout.

In his view, companies that emphasize big financial returns over establishing a positive corporate culture are not good candidates for ESOPS.

"The fact you have an ESOP will not make you a good company," Jochim says, "and if you're a bad company, an ESOP may not save you."

Experience has taught him that ESOPs typically work best for companies led by their owners/founders or second- and third-generation family members. They also are businesses that have built a reputation for providing sound management, creating a good place for people to work and making a profit.

"They're true family businesses in the best sense of the word," Jochim says. "If you're a good company, you'll have a good ESOP."

He says Roush Honda in Westerville is a perfect example of that. The late Edwin "Dubbs" Roush decided to go the ESOP route with his dealership in 1991 and also with his two other companies, Roush Hardware and Roush Sporting Goods.

"He was looking for an exit strategy for him and his family," recalls Roush Honda President Jeff Brindley, who has worked at the dealership for 34 years. "He also really wanted to provide an opportunity for the people who built the business to take it forward. If he sells in the traditional manner, most of us would not be here today."

Brindley is one of the 15 original ESOP participants still working at the dealership. Through the years, many other employee owners retired with sizable nest eggs from their ESOP. Brindley is convinced that employees having a stake in the company has been critical to Roush Honda's growth and success.

"Because of the ESOP," he says, "our culture is different than most businesses and certainly other dealerships. Our people are accountable to each other. A person in the service department understands how important it is that cars get sold, and a sales person understands how important it is that our service stalls are full every day.

"What you do here has an influence on how our stock performs. It's unique for employees to get to experience the same thing as a business owner. Our people come to work with skin in the game."

Roush Honda employees are fully vested in the ESOP after six years with the dealership. The company each year repurchases the stock from those who retired or left the prior year and reallocates the shares to the remaining stockholders. The value of those shares can grow depending on the dealership's financial performance.

Brindley says the ESOP is a big reason that people stay with Roush Honda-73 of its 225 employees have at least 10 years of service and 28 have 20 years or more. Among the Roush Honda veterans are sales people and managers, a group that typically jumps from one dealership to another.

"We are so blessed to have the benefit package we do," Brindley says. "Our managers stay and can be selective in whom they hire."

That sort of long-term buy-in by employees is what makes the Mills James ESOP work, too.

"That mentality is integral to the continuation of an organization," says Arthur James, a Mills James vice president and Cameron James' son.

"Getting everyone thinking like owners is in the interest of (company) growth and prosperity and staying relevant and competitive."

He says his father and Mills saw the ESOP as a way to "future-proof" the company as they looked to start the transition to a new ownership model and secure the company's future.

"This allows us to control our destiny more than we would otherwise be able to do," Arthur James says. "We can provide a future for ourselves and families by doing the work we find meaningful and make this environment the kind of place we want it to be."

For hair salon owner Kenneth Anders, an ESOP provided an exit strategy that he found much more palatable than selling the company he loved to an outsider. That was seven years ago when the founder of Kenneth's Hair Salons and Day Spas in Columbus started looking for a way to step back a bit from the company he started in 1977.

"This company was my baby," Anders says. "I couldn't see myself standing in front of my employees-some of them have been with us for 30 to 35 years-and telling them they may not work here anymore or me handing my long-time executives a cardboard box when the new owners brought in their own team."

So he began educating himself about ESOPs and found they can be a perfect fit for an organization such as Kenneth's. Now employee-owned, the company has more than 300 employees and operates 11 salons in central Ohio, including three with day spas.

Anders says employees are fully vested in the ESOP after three years and are issued stock based on their level of income.

"I had a lot of people who believed in my dream and helped make it come true, he says. "I want to do the same for them."

His advice to business owners considering an ESOP is to look closely at their employees and culture and ask themselves some pointed questions before proceeding.

"Are your employees devoted to your beliefs and what you've created?" Anders says. "Are they involved in making it grow? (The ESOP) was a perfect fit for us."

Anders continues to serve as company president and remains a stock holder in the corporation. But he has more time to kick back, including vacations in Florida. He hopes the ESOP will provide the financial means for Kenneth's employee-owners to take it easy when the time comes for them as well.

"I hope someday they're down here, too, drinking pina coladas and feeling the sand in their toes," Anders says. "Then they'll say, 'Thank you, Kenneth.'"

Jeff Bell is a freelance writer.