ESOPs – Truth or Fables?

Employee Stock Ownership Plans (ESOPs) can make wonderful business exit vehicles in some circumstances.  That said, ESOPs are commonly misunderstood and prematurely dismissed from consideration by business owners when considering a business exit.  Some would even go so far as to compare the claims of ESOP proponents to the works of the ancient Greek writer Aesop.  Aesop wrote fictional and often contradictory stories known as fables.  Yes, the claims of ESOPs can often seem to be that of fables, or in other words “too good to be true.” I can assure you that the beneficial claims of ESOPs are far from fables, so lets dispel some of the misconceptions.

• ESOP exits yield a lower selling price

  That is often true. An ESOP valuation is, by law, made at fair market value, which will surely be less than what you could get from a strategic buyer that sees synergistic value in your company, if you can find such a buyer. But you can’t bank your selling price.  You can bank the net.  In other words, its not what you sell for, but what you keep.  With the tax advantages allowed under ESOPs, it is possible that the net price you keep will be on par with that of a sale to an outside third-party.

• ESOPs are difficult and expensive to create/administer

  Again, this is partially true. That’s why you would hire a firm that specializes in ESOP administration and not try to do it on your own. The costs of creating/administering the ESOP will be far less than what would have been paid to an investment banker for selling your company to a third party.

• My employees will want to run the company

  Your employees will NOT control the company. In fact, they won’t even directly own the company.  They will have an indirect beneficial interest only.  They will not be shareholders, will not having voting rights, and will not have decision making authority unless, until and only to the extent that you give it to them. In many circumstances, the original owner(s) can maintain a significant, if not outright control over the affairs of the business long after sale to the ESOP.

What then are the advantages of an ESOP?

• Buyer creation

  Imagine selling your company yet not having to put your business on the market. Going to market risks employee stress, rumors of you “going out of business” as originated by your competition, etc. An ESOP creates a friendly, flexible, and negotiable buyer for your business.

• Tax advantages

  There are numerous and substantial tax advantages to an ESOP. There isn’t time or space to go into these tax advantages in detail now. The rules differ based on what type of corporation your company is, how much of the stock you want to sell, etc. Suffice it to say that these tax advantages seem “too good to be true” but thankfully are not.

• Control

  Under the right circumstances, you can sell your company to an ESOP and still maintain control. Again, the thought “too good to be true” comes to mind.

So what’s not to like about an ESOP?  An ESOP, although not for everyone, should at least be considered as a candidate for your business exit. I presently have a 30-year old general contracting client that will exit via an ESOP, as well as an engineering client that is perhaps a year or two behind. These situations allow for the present ownership to ease out of ownership/management over a comfortable time frame, and allow a strong 2^nd generation of managers to slowly take more responsibility and beneficial financial interest in the enterprise.

I hear you if you are still saying that there must be a catch, and that the ESOP advantages stated above must be too good to be true. Before dismissing the ESOP option consider that, according to the most recent NCEO statistics, there are over nine thousand ESOP plans in the US which manage over $1.3 trillion in assets and have 15 million participants. Maybe they are on to something. Or maybe I am a modern-day Aesop, writing this “fable.” I think it’s worth your time to check out these claims and decide for yourself.

Call me at 707 753-1588 or email shane@b2bcfo.com if you would like to kick these options around a little.