Ten years after founding Heartland Breweries in 1995, Jon Bloostein’s company became a victim of its own success. Profit was so strong that the Internal Revenue Service was collecting more than 40 percent of earnings, leaving Bloostein unable to tap his own cash flow to fund new restaurants.
So when he learned an employee stock ownership plan could lower Heartland’s tax burden and free up cash for growth, he was thrilled.
“We were growing well, but going to the bank too often to borrow money,” said Bloostein, founder and chief executive of Heartland.
Employee stock ownership plans, or ESOPs, gradually sell equity in a company to employees. They are tax-deductible to the selling shareholder, or the company, therefore reducing the corporate tax burden. In some cases, the dividends paid out from the plans also can be tax-deductible. Leveraged ESOPs, or plans that are sold to banks for loans, also provide an opportunity for the company to obtain attractive debt financing. Employees benefit, too, sources said, as ESOPs are tax-free to those receiving shares, at least until a payout is made.
At New York-based Heartland, which is now 49-percent owned by Bloostein and 51-percent owned by the ESOP, taxes were lowered substantially and the company now “has more money in the bank [and] cash we can use to expand,” Bloostein said.
For all of the positives, however, ESOPs do come with some headaches. Not only are they complex financial vehicles—Bloostein called his “almost counterintuitive and difficult to understand”—but also the professional and legal help required to set up an ESOP can be costly. Heartland initially spent nearly $500,000, and continues to maintain the plan at a cost of $50,000 each year.
Despite the hurdles, an ESOP is one of the fairest ways to share a company’s good fortune while keeping the taxman at bay, sources said.
“I don’t pull any punches when I [tell employees] why I did it,” Bloostein said. “I did it to save taxes. But the government wouldn’t let me do that without benefiting you. So when I grow the company for me, I grow it for you.”
At Zachary’s Chicago Pizza Inc., Zach Zachowski and Barbara Gabel viewed an ESOP as the ideal means of selling the three-unit Zachary’s Pizza chain to trusted employees and funding their retirement. The founders believed the interest-free financing would keep Oakland, Calif.-based Zachary’s management focused on operations rather than debt service.
“Any money made by an ESOP is tax-free,” J.P. LaRussa, the chief operating officer, said, “and that works really well for us because it leaves us money to spend on the business or to buy more shares.”
LaRussa called the administrative oversight for the plan “enormously bureaucratic,” but said the financing it creates has more than made up for it. Today, Zachary’s is 56-percent employee-owned. Its ESOP started in 2003.
Yard House Restaurants also saw an ESOP as crucial to its growth plans, but more crucial for the management morale it would engender. By sharing 5 percent of the company’s equity, its owners said they believed Yard House would attract high-quality managers who would stay with the company longer, reducing turnover and human resources costs.
“When you have more members of the team looking at the business with ownership eyes, it’s not just a paycheck anymore,” said Harald Herrmann, president and chief operating officer of Irvine, Calif.-based Yard House. “We’ve been able to bring people on board who saw the value of this.”