How Economic Cycles Affect ESOPs

November 28, 2023

Economists state competing theories about the state of the U.S. economy, current economic cycles, and what the future will hold. While no one can predict the future, we’ve seen that companies that embrace Employee Stock Ownership Plans (ESOPs) are often more resilient and steady, even in times of economic uncertainty. 

Economic Cycles and ESOP Valuation

All ESOPs undergo valuations. An ESOP valuation occurs at the initial creation of the ESOP (this valuation is called a Feasibility Study) and is also completed every year, throughout the lifespan of the ESOP. This annual ESOP stock valuation determines the fair market value of the company’s shares. ESOP valuations are completed by an independent appraiser, who then determines the fair market value of the ESOP’s shares. 

A variety of factors are considered when the appraiser completes a valuation. These can include: 

  • The business’ projected performance
  • The business’ debt-to-equity ratio
  • The company’s tax rate
  • The company’s competitive market
  • Public market comparables

Depending on the state of the U.S. economy, the initial or annual valuations can certainly be affected positively or negatively. However, because valuations are based on many other factors, economic outlook is not the only consideration. 

Employee Participation and Ownership Transition

Employee Participation & Employee Trust

Let’s consider the fact that the current unemployment rate is one piece of the economic outlook puzzle. When the labor market is competitive, companies are competing for good employees. Here’s where ESOPs tend to have an advantage, because they tend to have better company morale, productivity, recruitment, and retention. 

Why is employee participation and buy-in strong, when a company offers an ESOP? Well, when company performance has a direct, tangible effect on employee benefits, this motivates employees to work harder. All employee-owners can see how a more profitable company translates into higher share value, creating a source of pride, trust, and loyalty. 

Ownership Transition

Every business will inevitably need to work through an ownership transition. We’ve seen that an ESOP can be one of the best succession plans to ensure business continuity

Creating a plan for your business succession requires objective guidance and support. As company owners weigh their options, transitioning to the ESOP is one viable choice. 

ESOP Resilience and Sustainability

In 2023, the National Center for Employee Ownership (NCEO) released a report that summarized the findings of a study that was commissioned by the Employee-Owned S Corporations of America (ESCA). Among its findings, it found that ESOPs are more sustainable, resilient businesses. ESOPs also tend to: 

  • Perform better during an up-and-down economy 
  • Are more resilient during major economic events, such as the recent pandemic
  • Enjoy higher-than-average employee retention rates
  • Experience fewer layoffs than the national average

ESOP Sustainability During Economic Uncertainty

When employees are also owners, everyone benefits in the long term. ESOPs build generational wealth, promote a sense of shared ownership and success, and can lead to more prosperous and equitable businesses. 

If you are considering an ESOP for your organization, we are available to answer your questions. After overseeing hundreds of ESOP transactions, we can confidently provide advice on whether or not an ESOP makes sense. ESOPs are not for every company, and we will always make recommendations that are in the best interest of stakeholders.

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