There are various strategies business owners can employ to exit from their businesses or to simply provide liquidity for the owners when they want to remain in control of their companies. If you are a business owner, an employee stock ownership plan (ESOP) may be a useful tool to achieve your objectives.
“An employee stock ownership plan (ESOP) is a qualified defined-contribution employee benefit (ERISA) plan designed to invest primarily in the stock of the sponsoring employer. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and participants receive various tax benefits. ESOPs are often used as a corporate finance strategy and are also used to align the interests of a company's employees with those of the company's shareholders.” (Investopedia.com)
ESOPs can be highly effective for business owners that are interested in tax efficiency, want partial liquidity, want to maintain control of the company, and/or are committed to their employees and communities and want to maintain the company culture.
Various tax code provisions related to ESOPs can reduce, defer and/or eliminate taxes associated with the sale of the company as compared to a sale to a third-party buyer. This can result in the after-tax proceeds to the owner being higher than what s/he would obtain through an M&A transaction. It can also result in the ESOP owned company’s ability to operate on a tax free basis. That can be a great competitive advantage for the company.
While it is possible to sell part of a company to a third party or to a private equity firm in order to achieve partial liquidity for the business owner, it can be difficult and the third party or equity firm may want to control the decision-making and direction of the company. A business owner can sell a portion of his/her stock to an ESOP and maintain control of the company while still participating and benefiting from the company’s future growth.
Where the sale of a business to a third-party often results in a major impact to the company culture, there is minimal impact when selling a company to an ESOP. The employees’ jobs are protected and the company culture is largely unaffected.
Is an ESOP Right for You?
Not every business is a good candidate for an ESOP. Despite the tax advantages and other benefits to both the business owner and the company, an ESOP will generally make the most sense for companies that have little to no debt, have payroll (excluding owner) in excess of $1M, and have EBITDA of $1M or more. In addition, the business either wants to maintain control or wants his/her management team to maintain control and wants the company culture to remain intact. The business owner may also be community minded and want to ensure the business is not relocated.