An Employee Stock Ownership Plan, ESOP, isn’t new to the finance world. Companies across all industries take advantage of ESOPs. But while the idea dates back, Gellert Dornay, president and CEO of Axia Home Loans, which became 100% owned by its employees back in September 2016, gave a unique perspective on how this type of plan could be the key in creating a healthier mortgage finance market.
And, most notably, how an ESOP can help lessen mortgage default risk all while retaining great employees, which were both strained during the financial crisis.
As explained by the National Center for Employee Ownership, “ESOPs are most commonly used to provide a market for the shares of departing owners of successful closely held companies, to motivate and reward employees, or to take advantage of incentives to borrow money for acquiring new assets in pretax dollars. In almost every case, ESOPs are a contribution to the employee, not an employee purchase.”
The center noted that while ESOPs were almost unknown until 1974, ESOPs are now widespread. According to the most recent data, 6,717 plans exist, covering 14.1 million employees. Of this amount, finance, insurance and real estate companies make up 17% of ESOP plans, coming in third after professional/scientific/technical services (18%) and manufacturing (22%) companies.
A full explanation on how ESOPs work can be found on the center’s website. For starters, there's a brief description below:
An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan. Regardless of how the plan acquires stock, company contributions to the trust are tax-deductible, within certain limits.
When Axia Home Loans first became 100% owned by its employees, Dornay said, “An ESOP rewards employees who contribute to the company’s success by allowing them to share in the company’s future increase in value.”
Now about one year later, Dornay told HousingWire exactly how beneficial an ESOP can be: “When employees run the company, our decision methodology is different. Everything is in the primary best interest of the shareholders, who are the employees,” he said.
He explained that the decision more fairly compensates people and gives them ownership. Once people feel invested in their company and that they have partial ownership in it, employees are more likely to commit to a company longer. This is helpful in an industry that has a high turnover rate.
Taking it a step further, Dornay said that if employees run the company, then they have more skin in the game, and it creates less default risk on mortgage loans.
After the financial crisis, the government slammed the industry with mortgage regulations in order to ensure nothing like the 2008 collapse ever happens again.
An ESOP, in design, should create an added layer of protection from the likelihood of another crisis since if the company goes down, so does an employee’s savings. Just as lenders discuss the need for skin in the game for down payments, this would create skin in the game for employees.
This mindset behind an ESOP doesn’t happen instantly though. Ted Margarit, principal, corporate finance at Chartwell, explained that it could take a couple years for employees to see how much stake they have in a company and to feel like they are an owner.
But as time goes by, they’ll get the power and see the value in an ESOP, he said.
When employees feel like they own the company, he stated, they look for ways to reduce costs or expenses because it all accrues to their benefit.
Margarit said this change in employee mindset is something they see time and time again.
“Turnover is lower and recruiting is easier because you’re offering a benefit that other companies don’t offer,” he said.
“This is a great opportunity for business owners to change their corporate culture,” said Margarit.
But, he added, “every business is unique and you really need to seek out the proper advice."
For those considering an ESOP, Margarit noted these three major things in order for it to work:
- You have to be profitable because savings aren’t worth anything unless you are profitable.
- You need a minimum number of employees (about 20 -25 people) because of federal requirements.
- This is a long-term transition plan, so you need to make sure you have a next generation of leaders. If you don’t have that transition plan, you need someone there to run the ships.