Counsel for a mature ESOP company approached SES Advisors with concerns about a disparity in a clients ESOP benefits. A group of 20 employees who had been with the company during the ESOP debt repayment period had significantly larger balances than 50 newer employees who joined the company after the ESOP suspense shares had been allocated. This situation is commonly described in ESOP companies as a have/have not problem.
The company asked SES Advisors to project its repurchase obligations for the next 10 years and to devise a plan that would ensure that more of the ESOPs future wealth would be allocated more broadly to the employee base. The company and the ESOP fiduciaries wanted to ensure that the companys ESOP repurchase funding strategy would comply with ERISA and be fair to current participants.
SES projected the repurchase obligation using the ESOPs current census along with projections developed in consultation with the company and its valuation advisor. SES prepared a schedule of projected benefit allocations by participant through 2020. This projection was used as a baseline to compare the impact of various repurchase funding options and plan policy changes.
After several iterations, the company settled on a hybrid strategy that employed both annual company contributions and S Corporation earnings distributions. Future company contributions will be allocated based on a new allocation formula that limits the allocations to highly compensated employees. Substantial recurring employer contributions ensure that repurchased shares are constantly allocated to new employees.
As a result of the amended allocation formula and new repurchase funding strategy, the employees earning in the lowest one third of eligible compensation will see their benefits grow from four percent of ESOP assets to over 15 percent by 2025. Benefits for employees in the middle third of eligible compensation will grow from 17 percent to 25 percent over the same period. Meanwhile, the strategy will provide diversification for long-term employees and should have no adverse impact on the substantial benefits that were allocated to employees in the past.