I’m often asked why a business owner would choose an ESOP over other succession planning alternatives.
Considering most business owners have spent the greater part of their life building their company, it’s a once in a lifetime decision that requires careful consideration of the available alternatives. After all, you will only exit your business once.
The following is a brief discussion of the advantages of an ESOP versus the two most common succession planning alternatives:
- Independent Third Party Transfer (selling the company to a competitor or a private equity firm)
- Related Party Transfer (management / family buyout)
ESOP versus selling to competitor or investor
Selling to another company or private equity firm means giving up control. Independent third party buyers will do what they believe is in the best interest of their investment. Since there’s not one right way to run a company, the company post-acquisition could look a lot different from the company you built. In the case of a sale to a competitor, there is often a consolidation of operations, which may mean plant closures and/or reductions in workforce.
Once you’ve sold it, it’s gone. Your input and control of what the company looks like, long-term, is over.
Selling the company to the ESOP, on the other hand, is intended to keep the company’s culture, operations, identity and employees intact. The ESOP provides the necessary liquidity to the shareholders through a structure designed to create a long-term sustainable ownership transition, while at the same time providing significant tax advantages to the Company and the selling shareholders. A sale to an ESOP also allows the seller to continue to be actively involved in the business, whereas involvement after a sale to a third party will be limited or nonexistent.
ESOP versus management/family buyout
The biggest challenge to management or family buyouts is that the individual managers and family members rarely have enough money to buy the company. Even if financing is available, personal guarantees will be necessary which can put a lot of stress on managers who are not accustomed to that level of risk. Also, a management or family buyout does not offer the significant tax advantages that an ESOP has to offer.
A sale to an ESOP can keep the management team in place, and any borrowing incurred by the company to finance the transaction is effectively deductible (both principal and interest), which makes it much easier for the company to repay the transaction debt. Also, a sale to an ESOP may allow a seller to defer capital gains tax on the sale of the shares under a special tax code provision.
Sometimes a management/family buyout is done in conjunction with an ESOP. The ESOP will buy a portion of the shares and managers/family members will buy a portion, according to their means.
There are many other benefits of an ESOP:
- Gives you some control over what the company looks like going forward
- Solves the problem of ownership succession planning
- Gets the value you need out of the business
- Gives good news to the people still there – the company will continue
- Jobs are as safe as they were before
- The business is still there, which is good for the local economy and the owner’s legacy
- Your name association with the company is intact
An ESOP is not right in every situation, but given its significant tax and other advantages, it should be given consideration as part of most succession planning decision-making processes.
Paul Fusco is a Shareholder at SES ESOP Strategies.