PLANADVISER - November/December 2019 - 43

John Ellwood, sold part of the company to employees
through the first ESOP transaction, but at that stage he
actually remained the majority owner. "
Showing that ESOP transfers can occur in phases, it was
not until 2004 that Ellwood sold the remainder of the firm to
employees.
" The way it worked back at that time was that the shares
acquired by the ESOP from John were actually unallocated, "
Ward explains. " The shares had equity value at that point, but
they were technically held by the ESOP trust. The company
used some third-party financing to make this happen, which
we were able to pay back over the following few years. "
ESOP financing can work in several different ways.
According to the ESOP Association, the majority of the plans
(70%) are leveraged in some way, utilizing either third-party
financing or " seller financing. " A collateralized loan can be
issued either to the employer or directly to the ESOP.
In Ellwood's
case,
the ESOP's " unallocated equity "
structure means that, every year, all firm employees can
be granted shares from the trust. Ward says shares are
released from the trust annually based on a formula that is
tied to eligible compensation.
" What this approach has resulted in, if you fast-forward
to today, is that ownership of Ellwood Associates is very
widely distributed among employees, " he says. " Out of over
60 advisers and staff, nobody owns more than 10% of the
firm, and every single employee who has worked a full year
has accrued an ESOP allocation. "
Ward says he understands that some firms may not be
thrilled about the idea of turning to third-party financing to
enable an ESOP transaction, but, in the advisory space, this
may be necessary given the high value of such businesses
relative to the generally small number of staff.
" For advisory firms, the tough part on the front end is
figuring out how you can get the capital to allow the ESOP to
buy the business, " Ward says. " Given the challenge, I think
this type of effort to create an ESOP structure is oftentimes
going to be led by a charismatic founder or a single majority
shareholder. Once you navigate this step, it really becomes a
great structure that can disperse the equity among everyone. "
Rodgers agrees with that assessment, adding that advisory
firms and similarly structured professional services
entities can work through this difficulty by finding the right
partners and having the right strategic vision. In other words,
the financing may be tricky to organize, but it is definitely
not something that should hold advisers back from at least
considering creating an ESOP.
Ellwood's ESOP Success
" The pros for our organization as a whole have been amazing, "
Ward says. " The ESOP has been a strong retention tool for
employees, but especially our 25 lead consultants and other
senior people in the organization. Over the last decade, out of
those 25, we've had just three departures and one retirement.
So it's clearly helped us attract and retain talent. "
The ESOP also indirectly helps the firm hold onto clients,
because they can see and feel the enthusiasm and commit " Our
ESOP
structure
allows us
to retain
earnings
without
necessarily
being taxed
on them. "
ment of Ellwood's advisers
and staff, Ward suggests.
" Our client attrition rate has
been in the low single digits
for the last several years,
and I think the staff's ownership
mentality has a lot to do
with it. "
One clear benefit to the
firm itself is the tax efficiency
of the ESOP structure when it
comes to sustaining earnings,
year over year.
" In our case, the ESOP is
organized to be a retirement
benefit, and for that reason it
sits inside a qualified retirement
plan, which in turn
creates significant tax advantages, "
Ward says. " Our ESOP structure allows us to retain
earnings without necessarily being taxed on them. Compared
with a lot of competitors that aren't structured this way, we
have an advantage. Often, in professional services industries
such as ours, more of the earnings are paid out on an annual
basis and less is retained-in part because it can be detrimental
to retain significant earnings as a fully taxable entity. "
More ESOP Challenges
While the ESOP has been a great success at Ellwood, Ward
says, there are further challenges to consider. First and foremost,
the ESOP requires careful maintenance and extensive
ongoing education for staff.
" One potential con of the ESOP structure is that it can
be complex, especially with the structure we have in place
as an S-Corp ESOP, " Ward says. " Our structure means the
ESOP is tied into our nondiscrimination testing, which is
quite a complex process to manage, frankly. The rules for
what happens when people leave the firm can also be very
complex. We have low turnover, but it's been a little higher
among our newer hires in recent years. So, we need to make
sure they understand what will happen with their benefits
and what happens with the ESOP. "
Getting the governance structure correct is another
important and challenging task. " You have to ask, what's
the appropriate level of separation of the ESOP board
and company management? Considering things such as
[having] an outside perspective on the board is important,
as is communicating the governance goals and structures
to the employee-owners, " Ward advises.
He cites one other " problem " for Ellwood's ESOP-but one
good to have. " The company has done well, and so the retirement
benefit in the ESOP has compounded over the long run, "
he says. " The ESOP's success can lead to people having an
outsized amount of their retirement wealth tied up in the
company. There are positive reasons why this happened, but
we proactively help make sure our employees understand the
importance of diversification. " -John Manganaro
planadviser.com November-December 2019 | 43
http://www.planadviserdigital.com/planadviser/november_december_2019/TrackLink.action?pageName=43&exitLink=http%3A%2F%2Fplanadviser.com
PLANADVISER - November/December 2019

Table of Contents for the Digital Edition of PLANADVISER - November/December 2019
