Talk about a tough decision.

Dianne Gillmor Krumsee, chairman and majority shareholder of Old Fort Banking in Tiffin, Ohio, was ready to monetize a big stake in an institution her family had controlled for nearly a century, but no one in the clan's fourth generation had an apparent desire to get into banking.

No other insider could afford to buy the 45% stake the family was selling — valued at roughly $15 million — which raised the possibility that the local mainstay would eventually end up in the hands of a larger competitor. Eager to prevent such a sale, the $475 million-asset bank's president and chief executive, Michael Spragg, began looking for alternatives.

Spragg and his management team came up with a solution that only a handful of banks have used, arranging for Gillmore Krumsee's family to sell the stake to the bank's employee stock ownership plan. With Old Fort's immediate future secured, the ESOP is looking to eventually buy the remaining 54% stake in the bank's holding company, Spragg said in an interview last week.

"We're not aware of any bank that was able to take its ESOP from zero to 45% ownership in a single, integrated transaction," Spragg said. "ESOPs are very common in banking, but most are very small. This was unusual."

Employee ownership can be accomplished in a variety of ways. Employees can be granted stock options, buy shares through a profit-sharing plan or receive them in a bonus. ESOPs, under which workers receive shares as a benefit, are the most popular form of employee ownership.

Nearly 800 banks offer ESOPs, though most control relatively small blocks of stock, said Loren Rodgers, executive director of the National Center for Employee Ownership. Only 83 ESOPs own more than 25% of their banks and a tiny fraction has reached 100% employee ownership, Spragg said.

Old Fort joins a list of about 20 banks in Ohio that offer employee stock ownership plans, said Roy Messing, director of the Ohio Employee Ownership Center at Kent State University. Of those, he said his group is only aware of two instances where an ESOP's stake exceeds 25%.

Banks are a "good fit" for employee ownership, industry experts said. "Two of the best ways banks can compete are on service and cost control," which are enhanced when employees own the company, Rodgers said.

A company's productivity increases by as much as 5% in the first year after an ESOP is created, while data on company retirement plans has shown the savings of workers at firms with ESOPs are typically 2.5 times greater than those who work at companies without them, Rodgers said.

Old Fort's ESOP was well received, with employees rolling in a "higher than expected" amount of 401(k) money into the plan, Chief Financial Officer Michael Daniel said.

Old Fort, which earned $4.5 million last year, generated a 0.96% return on assets that was slightly below the 1.04% industry average. Spragg and Daniel said they expect the bank's performance to improve as employees gain a better appreciation of how much they will benefit from the ESOP.

"They won't fully understand what a great thing this for them until they get their second or third ESOP statement," Daniel said.

To be sure, ESOP ownership doesn't preclude Old Fort from someday being sold to another bank.

Though such transactions tend to be more complex due to the legal and tax rules governing ESOPs, a bank can still be sold if it receives an offer deemed adequate by the board and the trustees that oversee the plan, according to Todd Butler, an attorney with FisherBroyles in Atlanta who specializes in ESOPs

The positive reaction to Old Fort's ESOP extends beyond the bank. Leaders at a number of companies have called seeking information about the ownership plan, Spragg said.

The Ohio Center has also reported a spike in recent months of calls from companies interested in learning more about ESOPs, including a few community banks, Messing said.

ESOPs derive much of their appeal from the tax benefits. For employees, taxes are deferred until they cash in shares. Sellers can defer capital gains taxes by reinvesting proceeds in qualified replacement properties, a class of assets that includes shares of most U.S. corporations.

Advantages for sponsoring companies can be even greater.

A company's ESOP contributions are tax-deductible. Since ESOPs are the only tax-advantaged retirement plan allowed to borrow money, both principal and interest payments on their loans is tax-deductible.

Legislation currently under consideration by Congress would also encourage banks to lend to ESOPs by allowing them to deduct half of the interest income generated by such loans, as long as the borrowed money is spent to increase ESOP ownership of its sponsor company.

ESOP-owned S corporations "are essentially for-profit-tax-exempt entities," Butler said. "It can be an incredibly compelling structure in which a company can operate, essentially taking all of that money they would otherwise pay in taxes and direct it toward any corporate purpose."

The advantages of ESOP ownership extend beyond taxes, Butler said, calling it a "customizable" way to sell a company. "For instance, sellers can dictate how much they want to sell … [and] even if they sell all of their stock to the ESOP, they can remain in control of the business post-closing."

Additionally, ESOP's can pay fair market value for a company, as opposed to the hard bargains that private equity managers frequently drive, Butler said.

One factor people with ESOPs typically cite as a drawback has been the level of recordkeeping required by ESOPs, with Rodgers admitting that the complicated rules governing their tax treatment can create headaches for those who manage such plans. Worse yet, errors can trigger substantial penalties.

Still, the benefits outweigh the challenges, Rodgers said.

Old Fort chose an outside firm that specializes in ESOP administration to manage its plan.

"The job is incredibly complex," Daniel said. "We didn't want to get into a position where we had a problem."

The Old Fort deal also signals a major change in the shared history of the bank and the family that has controlled it.

Gillmor Krumsee's father and grandfather were former Old Fort chairmen. Her brother, Rep. Paul Gillmor, R-Ohio, who died in 2007, also chaired the bank and was a lead supporter of legislation to limit commercially owned industrial loan companies. Several family members also founded Panther Community Bank in Lehigh Acres, Fla., which was sold to the team behind First National Bank of the Gulf Coast in Naples, Fla.

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