Yesterday, we posted five reasons why you shouldn’t use an ESOP. Today, we visit five sound reasons to consider an ESOP for you, your company, your shareholders and your employees.
1. ESOPs are a tax-favored liquidity strategy that delivers fair value for shareholders.
Entrepreneurs often have several liquidity strategies available to create shareholder liquidity. ESOPs generally acquire company stock for fair market value, generally about at the same level as a private equity buyer. Moreover, a shareholder selling stock to an ESOP sponsored by a C corporation may be able to defer capital gains tax on the sale indefinitely under Section 1042 of the Internal Revenue Code. The ESOP company can also use tax deductible dollars to fund shareholder liquidity. The result is a tax favored sale at fair market value.
2. ESOPs allow for a “low and slow” ownership transition
For many entrepreneurs, their involvement in their company is not just an investment, it is their life’s work. Often, entrepreneurs want to remain involved and contributing to the companies they have created and grown but don’t want to work for a new “boss” that doesn’t understand fully the Company’s history and advantages. ESOPs facilitate an entrepreneur’s succession and transition strategy, allowing the entrepreneur to graduate slowly from CEO to board chair to retirement, while helping to preserve the value and values of the Company.
3. ESOPs benefit the people who have helped create value in the Company.
ESOPs create employee stock ownership and the opportunity for wealth creation for the employees who have contributed to the success of the Company. Employees in the current economic environment are generally challenged to achieve significant savings and wealth for retirement. ESOPs benefit employees, creating retirement savings on average significantly in excess of what employees can attain through other retirement plans. As several of our clients have described it, ESOPs are a way both to do well and to do good. Finally, companies that have employee ownership and employee involvement on average significantly outperform their non-employee owned counterparts
4. ESOPs create tax-favored independent and sustainable companies.
Many ESOP companies are or become “S” corporations. In an S corporation, all of the Company’s taxable income is attributed to the Company’s shareholders. An ESOP is a tax-exempt pension trust that pays no current tax on its share of S corporation income. Therefore an “S” corporation that is 100% owned by the ESOP is effectively a tax-free organization. This creates significant extra cash flow for the Company to repay stock acquisition debt and to have capital to grow and thrive. ESOP companies operating under this regime have a significant competitive advantage and are better able to remain independent, successful and sustainable for the long run.
5. ESOPs create and preserve legacy
For many business owners, their companies reflect both an investment and a mission. The Company reflects a lifetime of work and both value and values driven decisions. Outside financial buyers often are poorly equipped to see the real value and values of the Company. ESOPs and employee ownership can preserve the legacy of the founders and key entrepreneurs, allowing a new generation to move the Company forward.
ESOPs are not the right tool for every Company, and sometimes there are good reasons not to use an ESOP. We have many clients, though, who have discovered good reasons to do ESOP transactions and have realized the financial, tax, organizational, personal, and legacy benefits of ESOPs. You owe it to yourself and your company to learn more about ESOPs and to figure out whether the good reasons to do ESOPs are compelling reasons for you and your company.
To learn more about the benefits of ESOPs, please visit our Knowledge Center.