Companies that set up employee stock ownership plans run the risk of creating future cash-flow problems unless they plan for repurchase liabilities -- the funds that will be needed to buy back the stock shares of employees who retire or leave the business. Take the case of McKay Nurseries, in Waterloo, Wis., which set up an ESOP in 1984. "We are setting sales and earnings records every year," says Griff Mason, McKay's president. "The more value the company generates, the more cash we're going to need to handle ESOP liabilities when they come due. We began to worry that we would have to set aside millions just to pay off one of the 18-year-olds on our staff."
Bob Dema, president of CPI Qualified Plan Consultants, in Great Bend, Kans., explains that as many as 28 factors relating to a company's financial and work-force development can affect the future size of its ESOP repurchase liabilities. Since some of the calculations are based on actuarial assumptions, it's usually necessary either to purchase a specially designed software product, as Mason ultimately did, or to hire consultants every three years or so to develop estimates that will keep funding plans on target.
"The two scariest scenarios occur when a company experiences rapid growth, so its stock becomes much more valuable, or experiences a financial decline, so it has to lay off workers and buy back their ESOP shares," says Dema. "In either case, there's a tremendous drain on cash that could bury a company unless it has planned accordingly."
Short of avoiding ESOPs altogether, companies can choose a conservative plan design. Mason is committed to meeting his plan's obligations, and he wants to be ready when payoffs come due. "We're aggressively setting aside enough cash each year to be able to meet our actuarial projections. We don't intend to have to sell off our business simply to pay off our ESOP obligations." -- Jill Andresky Fraser* * *
McKay now relies on PERLS (Professional ESOP Repurchase Liability Software) to help it calculate its future liabilities. For use on IBM compatibles, PERLS costs $4,795. (A onetime cost of hiring a consultant to conduct a study runs $3,000.) PERLS is available from Benefit Consultants Inc., at 800-666-0144.