As private company owners deal with the succession and transfer of their businesses, we are seeing an increasing interest in using an employee stock ownership plan (ESOP) as a transfer strategy.
Determining your transfer strategy is a highly complex process that takes time, analysis, serious thought, and good advice. This assessment is multi-faceted and involves the future of the company and its employees, financial considerations, family considerations, legacy issues, and the owner’s ongoing role at the company.
Below are a handful of pertinent questions to ask yourself to determine whether an ESOP may be right for your company.
- Do I want more control of the transition and succession process? An ESOP sale provides a reasonably high level of control to the existing owners. The exiting owner has the ability to decide the timing of the transaction, the amount of the company that will be sold (100 percent or a minority stake), continuity of the management team, and their own ongoing role in the company. The day after the ESOP transaction, the people who were running the company are still in the same roles, including the owner.
- Do I have multiple transfer objectives? An owner’s transfer strategy always involves money, but money is rarely the only factor in the decision. Whenever we counsel exiting owners, we suggest that the first step in the process is to write down all of the things that matter to them in the transfer and establish their priorities. Many have grave concerns about what will happen to their business, its legacy, and its employees in a third party sale. These concerns are real. An ESOP allows for the ability to achieve multiple transfer objectives.
- Do I want flexibility in my transition plan? An ESOP sale does not need to involve 100 percent of the company’s stock; the transaction can be for a minority stake. Many owners like this option because they have the ability to “test drive” the strategy to see how it works and to make sure they are comfortable with the approach. Selling a minority stake (or a series of them) can allow an owner to execute their succession and transfer plan over many years.
- Do I want to diversify my wealth? For the owner who is not ready to retire but who has the bulk of their net worth tied up in their company’s stock, an ESOP sale can provide the best of both worlds. The partial sale of stock to an ESOP allows the owner to invest the proceeds elsewhere and diversify their risk without taking any drastic steps in terms of their day-to-day role at the company.
- Do I want to gradually change my leadership role at the company over time? One of the biggest issues in an owner’s transfer strategy is their ongoing role at the company. The business is an important part of their identity and provides a great deal of personal gratification. If that part of the owner’s life ends abruptly, it can create serious issues in terms of finding meaning and fulfillment. For many, it feels like jumping off a cliff. We counsel these owners to think of the process as more of a ramp than a cliff, with a long-term, steady adjustment of one’s role. An ESOP transaction allows the exiting owner to plan and execute the succession of their role gradually, rather than feeling as if they are jumping off a cliff.
ESOPs are complex, and there are certainly many issues to consider with an ESOP transaction. These include taxes, financing structure, and quality and age of the management team, to name a few. However, if the answers to the above questions resonate with you, you may want to give serious consideration to pursuing an ESOP as your transfer strategy.
Mario O. Vicari can be reached at Email or 215.441.4600 if you wish to discuss this article or ESOP strategies.
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