We like to think that shareholder/entrepreneurs are really investors in their companies. While that is true by itself, it isn’t the whole story.
When I talk to a shareholder/entrepreneur, I’m not only talking to an investor. I’m usually talking also to a key executive, board member (sometimes the sole board member), who has important relationships with his management team and employees, including family members in the business, as well as the community and the industry.
The liquidity/succession decision rarely gets made purely as an algebraic calculation of value and return. Most shareholder/entrepreneurs want and insist on a “fair” return on their investment and their (life’s) work. At the same time, many care deeply about other important outcomes, including their and their family’s ongoing role in the business, as well their “legacy” in and through the company.
For these shareholder/entrepreneurs, ESOPs solve many problems, including:
- ESOPs help shareholders achieve good value for shareholders by paying a price equivalent to a private equity buyer and creating significant potential tax advantages and savings for the ESOP company and the selling shareholders.
- ESOPs allow for slow transition of management and control. Many entrepreneurs do not want to retire completely but rather prefer to evolve from CEO to board chair, “cherry-picking” the things that they like to do in the business where they add the most value. ESOPs also provide security and opportunity for family members in the business.
- ESOPs create ownership reward and incentive for management and employees. Most entrepreneurs do not build great companies all by themselves and value the opportunity to create a benign and positive outcome for their people.
- ESOPs preserve company independence and identity. Many companies succeed because they are independent and have a strong identity and approach to the industry and the marketplace. ESOPs allow for continuation of the founding ethic and approach to the business.
Why doesn’t every shareholder/entrepreneur use an ESOP for liquidity and succession? ESOPs are less advantageous if the shareholder/entrepreneur wants an immediate full cash payment and an immediate and full exit from the business. Sometimes there are strategic buyers who may pay a significant premium for the company. ESOPs are somewhat complex and not always well understood.
Every company, every shareholder/entrepreneur, and every situation is different. ESOPs are an important alternative to the inertia or fear of planning an exit strategy and the default option of selling the company to the most willing third party available at the last possible moment.
James G. Steiker is President and CEO of SES ESOP Strategies.