Exit Strategy – Have You Considered an ESOP?

The decision to sell impacts your management team, your employees, and your own state of mind.  Deciding when and how to sell your business is a nerve-wracking time, and it can prove exponentially more difficult if you do not have a solid exit strategy that includes consideration of employee benefits and your transition plan. Personnel issues and your plan to effectively transition into retirement should be part of your exit strategy from the beginning.

There are many reasons to consider making an Employee Stock Ownership Plan  (ESOP) part of your exit strategy.  An ESOP is an employer funded benefit program set up to hold the company’s stock on behalf of employees. To effectively finance an ESOP a bank loan or seller financing is often necessary. But favorable tax laws sometimes make it much easier for a company to pay off ESOP debt than third party debt resulting from a more traditional leveraged buyout (LBO).

Many business owners are seeking similar traits in a potential buyer of their company. These traits are primarily focused on non-financial objectives and include:

  • willingness to give the current owner a transition period of several years
  • buyer doesn’t demand that the seller liquidate every share at once
  • preference for a fixed-price transaction
  • buyer comes from the community or better yet the company
  • buyer will retain the entire workforce including office staff
  • willingness to give the “bench” an opportunity to step up and lead the organization upon the seller’s retirement

If you’ve determined that the situation described above is too good to be true, you might want to look into an ESOP.

Frequently, ownership is transferred to the ESOP in stages with the seller staying involved in the day to day operations of running the business. The business and all jobs remain in the community. A fixed sales price is often determined. And sellers are often surprised by the tax benefits resulting from an ESOP.  For example, capital gains taxes resulting from the sale of C corporation’s stock to an ESOP may be deferred or avoided. In addition, an ESOP-owned S corporation escapes federal income taxes at the corporate level AND at the shareholder level.

An ESOP allows a retiring owner to retain control over the transition process and puts the company in a tax-advantaged position for years to come. It’s certainly worth considering as you decide on the most effective exit strategy for your business.