NUL Senior Editor Warren S. Hersch recently met with Jerry Ripperger, director-consulting of Des Moines, Iowa-based Principal Financial Group. The interview explored company and industry developments in respect to employee stock ownership plans: tax-qualified defined contribution retirement plans in which employees have partial ownership of the business. The following are excerpts.
Hersch: Which types of businesses are key prospects for an ESOP transaction? Are you finding greater interest in ESOP among these companies than in prior years?
Ripperger: Manufacturing companies and professional services firms make up more than 20% of our ESOP prospects. Ultimately, the attributes of the company and the financial goals of the business owner will determine whether a prospect is well-suited to an ESOP.
Many people say you can't do an ESOP for, say, convenience store chains because these business experience high turnover of full-time employees. But those chains that are ESOPs don't have high turnover—challenging the assumption.
Hersch: How are ESOPs advantageous from a tax perspective?
Ripperger: A lot manufacturers have found out that the only way they can be competitive is to convert to a 100% employee-owned S-Corp. Because the business is 100% owned by an ESOP trust and because the S-Corp. is a pass-through entity, the business can pass through profits to a non-taxable entity: the ESOP trust.
Also, state economic development councils recognize that ESOPs are advantageous in terms of keeping home-grown companies from moving out-of-state. For example, Iowa's governor has signed a law—the first of its kind—that provide incentives to business owners to use ESOPs to keep businesses in the state.
In Iowa, if you sell at least 30% of your business to an ESOP, you get a 50% exemption from the state’s 8.9% capital gains tax. So by selling to an ESOP, you can add 4.4% to the value of your business. Indiana, Ohio and Vermont offer similar tax incentives.
Jerry Ripperger, director-consulting of Des Moines, Iowa-based Principal Financial Group.
Most states' economic development organizations spend a lot of money promoting the benefits of doing business in their states, but generate few jobs. By offering tax incentives to business owners that convert to ESOPs, these organizations can retain jobs—and generate additional revenue. That’s because becoming an ESOP is, on balance, contributory to tax coffers.
Hersch: How much interest have you generated from the advisor community in promoting ESOPs?
Ripperger: Advisors are very interested. We've held several dozen events—typically a one-hour lunch or breakfast meeting—about ESOPs for financial service professionals, among them mutual fund advisors and life insurance brokers. We expect to have another 25 advisor gatherings in 2013.
The advisors we recruit don't need to be experts in ESOPs; they just need to understand when the plan fits as a solution and know some conversation-starters for business owner prospects. Our ESOP consulting team will make sure to involve the advisor when there is a life insurance sales opportunity.
Hersch: Are ESOPs as attractive to employees as to business owners? Do companies structured as ESOPs generally also offer employees a separate retirement plan like a 401(k)?
Ripperger: Typically, employees don't contribute to an ESOP, a company-funded benefit that operates much like a traditional profit-sharing plan. The average ESOP balance in the U.S. is $195,000—about three times the average 401(k) balance. That said, we strongly recommend not eliminating a 401(k) because you want the employee to have the ability diversify among different asset classes.
Hersch: Beyond the initial seminar, what education does Principal Financial offer advisors about ESOPs?
Hersch: How might an ESOP be structured if the business owner's children also want to be involved in the business?
Ripperger: The ESOP doesn't have to own 100% of the business. If you want to pass 70% of the ownership to your kids and 30% to the ESOP, that's perfectly allowable. And you can use life insurance to compensate other children who might not have a vested interest in the business.
If there are three kids—two of whom are active in the business, and the other not—you might do a 33% ESOP to generate a cash opportunity to buy out the child who doesn't want to stay in the business.
Hersch: While Principal Financial is active in this ESOP space, I haven't observed this of other carriers. Why so?
Ripperger: The players that focus on ESOPs tend to be stand-alone companies. Among the companies are Blue Ridge ESOP Associates, The Menke Group and Crowe Horwath LLP.
I can't think of another life insurer engaged in this market.
To be active in this space takes focus: You really have to understand strategically how ESOPs fit into a company’s and business owner’s plans; and you need a deep body of expertise.
As an insurer, you generally wouldn't try to build this expertise in-house, but rather acquire it from an outside firm that specializes in this market. And, in fact, we bought a company to get into the business: the former Benefit Consultants Inc. of Appleton, Wis.
Hersch: How much ESOP business does Principal Financial do relative to the competition?
Ripperger: If you look at the largest 15 providers of defined contribution retirement plans, we do more ESOPs than the other 14 put together. This is not a sideline business for us, but rather a major part of our strategy.
ESOPs create insurance opportunities for our U.S. insurance solutions business, assets for our mutual fund business and retirement plans for our retirement plan business. ESOPs also are a value-add to help us build relationships with our career agents and with mutual fund professionals and retirement plan providers.