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Communicating the fabled ESOP.

Communicating the Fabled ESOP

The good news is the chief executive officer is excited, the chief financial officer is excited, and the communication budget won't be a problem for a change.

The bad news is corporate counsel is looking dour, the vice president of human resources is looking nervous, and your office is crawling with investment bankers, benefit consultants, and representatives of out-of-state law firms.

Congratulations! Your organization is about to become the proud possessor of a leveraged ESOP--short for employee stock ownership plan. Or more correctly, a leveraged employee stock ownership plan is about to become the proud possessor of your organization ... or at least a significant portion of its common stock.

As the person responsible for internal communication--including (lucky you) employee benefit communication--you're faced with the challenge of communicating a significant change both for your organization and for the benefit program. You know your audience, and you're an old hand at announcing changes in medical deductibles, expanded dental benefits, and increases in the company's matching contribution to the 401(k) plan. But this is a plan of a different color.

For openers, what is an ESOP anyway? What are the major messages your communication materials should send? What kinds of questions are employees likely to have? Are any gremlins likely to appear in the planning and implementation of ESOP communication?

Clearly, the communication of your ESOP will depend both on the ESOP itself and on your organization. But after being involved with nearly a dozen leveraged ESOPs, here are some general observations.

Defining an ESOP

In general terms, an ESOP is an employee benefit plan that invests its assets mainly in the stock of the sponsoring employer--either preferred or common stock. All of the stock in the plan must be credited to eligible participants over a given number of years. Participants have the right to vote the shares they own through the plan. They also have the right to tell the ESOP trustee how to handle their shares in the event of a tender or exchange offer. (In most cases, voting and tender or exchange instructions are completely confidential between each individual employee and the trustee.)

If the company's stock pays dividends, it must treat ESOP dividends in one of three ways:

* By paying them to participants in cash. Dividends paid in cash, called "pass through" dividends, are taxable in the year of payment.

* By reinvesting them in additional shares of company stock, which are then credited to participants' accounts.

* By applying the dividends to repayment of the ESOP loan (explained later).

Under current US law, the employer can take a tax deduction for dividends that are paid in cash or applied toward the loan repayment.

Some ESOP provisions are required by law. For example, the plan must offer alternatives to investment in company stock as participants near retirement. And annual employer contributions to the ESOP and all other retirement benefit plans for any one individual can't exceed certain limits set by the US Internal Revenue Service. These limits can create potential communication hurdles you should be aware of. Again, more later.

At the heart of a leveraged ESOP is The Loan--the mechanism for determining how many total shares of stock the plan will credit to participants' accounts. To understand what benefits the ESOP offers both them and the company, employees need to understand the role of the loan, at least in general.

The specifics of financing mechanics and the amount involved vary. But the basic financing mechanism tends to work like this:

* Initially, the company borrows money from an outside source and loans it to the ESOP. Or the ESOP may take the loan directly.

* Either way, the ESOP uses the loan to buy shares of company stock. The plan is committed to repaying the loan over a fixed period of time. The company is committed to guaranteeing full loan repayment. Seven years, 10 years, and 15 years are common repayment periods.

* Initially, all of the shares of stock the ESOP buys are held in a general account of an ESOP trust fund.. the "suspense account." Each ESOP participant has an individual account in the ESOP trust fund. As the ESOP repays the loan, stock is transferred from the general account in the trust fund to individual participants' accounts.

* In each year during the term of the loan, the company contributes an amount to the ESOP that is equal to the principal and the interest due on the loan for that year. The contribution may be reduced by dividends used to repay the loan. The company is committed to making that contribution regardless of profits.

* Different ESOPs use different formulas for figuring the number of shares transferred. One approach is to transfer the stock evenly over the loan repayment period--1/10 of the total in each year of a 10-year repayment, for example. Another is to transfer the number of shares that can be purchased with a given year's principal payment on a certain date.

* Different ESOPs also use different formulas to determine the number of shares credited to individual plan participants. For example, an ESOP may be a stand-alone benefit plan or part of a Section 401(k) plan. (In the latter case, it's often called a KSOP.) If it is a stand-alone plan, the number of shares credited to individual participants is often a percentage of pay. If the ESOP is part of a Section 401(k) plan, the stock is credited to participants as the company's matching contribution.

* This process is repeated in each year until the loan has been repaid. At the end of the repayment period, all of the stock in the trust fund will be in participants' accounts.

What to Say Next

Beyond the "how it works" part of the message, what do employees need to know about their new benefit plan? Experience suggests a number of potential messages:

* In these days of acquisitions and takeovers, many employers are placing substantial amounts of stock in employees' hands. However, the ESOP is first and foremost an employee benefit plan. It builds up capital for participants over the long term--primarily for retirement. It also offers them significant tax advantages.

* The stock usually costs participants nothing. I remember one focus group discussion of an ESOP after the plan had been in place for several years. When participants were asked to identify the primary advantages of the plan, the answer was a resounding chorus of "Free stock!" This is especially likely to be the response if company stock is doing well.

* Because of the way the plan is financed, the company has a stronger commitment to contribute toward employees' retirement income than it may have through a profit sharing plan. It must make the loan repayment regardless of profits.

* ESOP participation makes participants part-owners of their company. As a result, the plan creates a kind of financial and emotional partnership between the employer and employees. That partnership has benefits for both partners.

For employees, it means the potential to participate directly in the company performance they help create. As a result--as one CEO has expressed it--each person is more likely to weigh his or her individual actions on the job through the eyes of an owner. Participation also offers full voting rights. In case of a hostile takeover, that gives employees a greater voice in their own destinies. And in most cases, participation offers dividends.

For the employer, the ESOP loan offers access to a large amount of capital for a significant period of time. Because the loan is used to buy shares of stock that are credited to employees, the company can borrow the money at a favorable interest rate. As explained earlier, it can also tax-deduct dividends paid in cash or applied toward the loan repayment.

What Questions to Anticipate

Some employee questions about an ESOP are fairly easy to anticipate. In effect, they are the same ones you would ask as preparation for developing communication material:

* Why is the company putting the ESOP in now?

* What's in the ESOP for me?

* What's in it for the company?

* How much stock will the plan buy? How much will I get?

* How will the ESOP affect our other benefits?

* In some environments: Isn't this really a defense against hostile takeover?

* Isn't this kind of plan riskier than other types of retirement plans, because of the company stock?

* Can I take money out of the plan while I'm working?

* When do I get my account?

Managers, supervisors, and others with day-to-day responsibility for employee communication will have the same issues prefaced by "What do I say when they ask...?" They also may need to be aware of additional issues:

* What happens to the ESOP when the loan has been repaid?

* Will the plan have any effect on the money available for direct pay?

* Can the company decide to make the ESOP bigger later on? That is, can it increase the ESOP loan and place greater amounts of stock in participants' hands--or can it take another loan when the first one has been repaid?

* What happens if we acquire another company? If another company acquires us?

Upper management will have its own questions too--most likely about the relationship between the ESOP and other company stock opportunities available to key employees.

As with any other kind of employee benefit communication, keeping these issues in mind can help ESOP communication be on target. You may also find that printed questions and answers addressing potentially sticky issues up front can help dispel confusion or dissatisfaction before it starts.

Two Potential Concerns to Answer

At least two of these questions come under the heading of "potential concern." One is the issue of investment risk close to retirement. Another is the effect the ESOP may have on other retirement benefit plans.

The Risk Issue

All common stock involves risk, of course. And concentrated investment in the common stock of one company has the potential for both significant long-term gains and significant losses. However, by law, an ESOP offers safeguards against investment risk for participants nearing retirement age. At a minimum, participants aged 55 or older with 10 or more years of plan participation must have the option to transfer part of their accounts out of company stock and into less volatile investments. The alternate investment funds may be a part of the ESOP itself or part of another benefit plan, such as a Section 401(k) plan.

Effect on Other Benefits

Depending on how much stock the ESOP (or the company) buys, the employer may need to reduce its financial commitments to other types of compensation and benefit programs. This is a tough but critical message.

The main reason is often cost. Most employers simply can't afford to add an ESOP on top of existing compensation and benefit arrangements. For example, to avoid doubling expense, an employer may shift funds from an existing 401(k) plan to the ESOP. The result can be a reduced 401(k) match--or no 401(k) match at all.

Another reason may be the Internal Revenue Service, which places a great many limitations on the tax-deferred amounts that can be contributed toward individual employees' retirement benefits each year. The IRS also requires a certain balance at all pay levels among both employee deposits and employer contributions to qualified retirement plans. Shifting some of the dollars available for retirement benefits from a Section 401(k) plan to an ESOP may be necessary for an employer to meet IRS requirements.

Some Awareness Factors

* A tight time frame. ESOPs usually happen very quickly. Concept and announcement can be literally days apart. But however rushed you are, spending some precious up-front time on planning will pay off handsomely later on. Gather the principal people involved together in one room. Set general communication objectives and identify major messages to be sent about the ESOP. Determine what tools will be used and what job each tool should be doing. Make a list of all the tasks to be accomplished in the announcement effort. Put a schedule down on paper. Determine responsibility for the tasks to be performed. Outline a realistic review process. Get agreement from your team.

* Strict confidentiality. In most cases, ESOPs are highly confidential until they actually take effect. The reason is the effect that prior knowledge might have on stock values. Early in the process, ask whom you can involve internally in the development of communication materials. The answer may be "no one." As a result, you may need to rely on outside resources more than you normally would.

* Technical, detail-oriented reviewers. You're likely to have a combination of lawyers, investment bankers, actuaries, and retirement benefit design consultants involved in developing and revising communication materials--also internal financial people, administrative people, and human resources people. View them as resources, not threats. Ask lots of questions. Don't be intimidated by their jargon. Use them as sounding boards. But remember their time is as tight as your own.

* Legal ramifications. While the concept of a leveraged ESOP is relatively simple, the Internal Revenue Service and Securities and Exchange Commission rules surrounding ESOPs are not. You must have legal review and approval of all communication materials. Build the approvals into your schedule and get them, no matter what.

* The CEO. Most ESOPs receive personal attention from very high-level officers. Announcement materials often go out over the CEO's signature. CEOs have been known to deliver personal ESOP messages on video tapes, edit copy for ESOP communication materials, and appear unannounced at employee meetings where ESOPs are being introduced. In making your communication plan, you may need to recognize the need for CEO involvement more than you would for other kinds of benefit communication.

* A secret weapon. As you know, managers and supervisors are an excellent channel for communication, especially for answering employee questions. Use this channel to your advantage. Distribute ESOP communication materials in advance to managers and supervisors, even if it's only a few hours in advance. Also consider arming them with potential questions and answers.

Communication Tools

What tools make for a successful ESOP communication campaign? Again, the answer depends in large part on who you are as an organization. A range of possibilities exist:

* An announcement of the ESOP to all employees. This often takes the form of a letter from the CEO transmitting a press release announcing the ESOP to the general public--although some marketing-minded organizations have used bright, visual mini-posters for the announcement step with great success. Whatever the format, the trick is to keep this piece short and sweet. For one thing, you want employees to read the announcement, not throw it away. For another, you may not have many specifics to announce. It isn't unusual for ESOP design to be finalized after announcement.

* Once plan design is complete: newsletters, articles in existing publications, bulletin board announcements, or some other interim communication tool that lets you deal with one-time, old/new issues. These kinds of pieces also help introduce major ESOP elements in relatively small, digestible bites: the loan, the process for transferring shares to individual accounts, calculating amounts transferred, voting rights, etc.

* A longer interim printed summary of the plan as it will work after implementation. This piece can fill a number of roles: a promotional piece on the plan; an interim reference before summary plan descriptions are available; background for enrollment, if the ESOP is part of a 401(k) plan; a nice meeting handout, if meetings are held; ongoing use with prospective employees, new hires, and newly eligible employees.

* Employee meetings featuring an audiovisual presentation on the ESOP. Meetings are feasible for some organizations, not for others. If feasible, meetings offer an excellent opportunity for a media mix as well as a forum for questions. Audiovisual presentations can be tailored to audience, timing, and budget, ranging from simple speaker-support slides to elaborate video productions.

* Follow-up communication. Too many times, organizations do a beautiful job of announcing an ESOP and then drop the ball on follow-up communication. Keep ESOP information coming, through enclosures to periodic statements of account, letters from the CEO reporting on company performance, and "annual reports" for ESOP stock holders. Several organizations I'm aware of maintain high, positive ESOP visibility by prominently displaying the value of company stock daily, with an ESOP-related message close by.

* Employee involvement. Remember that employees are part-owners now. Get their ideas on ways to improve company performance--and ESOP communication.

* The inevitable summary plan description. An SPD is due 120 days after the ESOP first takes effect.

Challenging... But Rewarding, Too

After all the plan designers, legal eagles, systems wizards, and investment bankers have done their work, the real connection between the ESOP and the employees who will benefit from it is communication. That's your job--and it's a critical one. Communicating an ESOP can be more challenging than other kinds of benefit communication. However the potential rewards--employee understanding and appreciation of these powerful benefit plans--can be tremendous.

Sue L. Prange is a partner with Hewitt Associates and a consultant and unit manager in the firm's Western Center Communication Group, Chicago, Ill.
COPYRIGHT 1989 International Association of Business Communicators
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:employee stock ownership plan
Author:Prange, Sue L.
Publication:Communication World
Date:Sep 1, 1989
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