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Top reasons to consider an ESOP

June 2, 2017

Companies often see profits and productivity rise after adopting an ESOP structure

In the lifecycle of every company, owners must face the question of ownership succession. Many alternatives exist and circumstances specific to the business owner’s interests and preferences typically dictate the chosen alternative. Although more highly publicized ownership succession strategies are usually at the forefront of consideration, lesser-known strategies should be given equal consideration. One of those strategies could be selling to an Employee Stock Ownership Plan (ESOP). Some of the top reasons to consider an ESOP are as follows:

You want to sell part or all of your company: An ESOP is an alternative buyer to a strategic or financial buyer. In addition, since most third party buyers are only interested in buying the entire company, an ESOP provides a business owner with an opportunity to facilitate a partial sale of the business.

You want to preserve the company’s legacy: Strategic buyers and private equity firms often will make changes to the organization post-transaction.  In many instances, those changes involve employee layoffs, new leadership brought in from outside the company, a change in company culture, and even a name change. The potentially negative implications on a company’s employees and management, corporate culture and values, and communities can be unappealing to business owners wishing to preserve a company’s legacy. Conversely, selling to an ESOP facilitates a sale of the company for the benefit of the employees. Employees receive an economic interest in the company and are able to financially participate in the company’s future success. As a result, post-transaction is generally business as usual with no immediate change to headcount, management leadership, or company culture and values. An ESOP is a buyer that preserves the pre-transaction operations of the company post-transaction.

You are interested in the tax benefits: When you sell your company to any buyer other than an ESOP, you will pay capital gains tax on proceeds from the sale. However, when you sell your company to an ESOP, you may be able to defer the capital gains tax. As a result, the net proceeds to a business owner from the sale to an ESOP may be more than the net proceeds available from the sale to a strategic or financial buyer after taxes are paid. Furthermore, an additional tax benefit inures to the company. If the ESOP purchases all of the common stock of the company and is an S-corporation post-transaction, the company will be exempt from paying Federal and state income taxes. If the ESOP owns stock in a C-corporation, the company will be able to make tax-deductible contributions to the ESOP that reduces taxes. In either scenario, the absence of tax payments enables a company to retain more of its earnings that can be used for other purposes, including debt repayment, capital expenditures, working capital, etc.

You are interested in attracting and retaining employees: Because employees have an economic benefit in the success of the company, numerous studies have shown that ESOP participation can be a great tool for motivating performance, retaining employees, and attracting new employees. As a result, additional research shows enhanced productivity as employee ownership participation incentivizes best practices and efficiency.

You are interested in providing employees with a wealth-creating benefit: An ESOP is governed as a retirement plan that provides for broad-based participation upon an employee’s achievement of eligibility requirements. Once again, numerous studies of employee ownership have shown that the economic benefits created for employees through in an ESOP are far higher than economic benefits created through more traditional retirement plans.

As a business owner, if the aforementioned reasons are consistent with your own personal goals and objectives, then a deeper discussion with a qualified financial advisor regarding ESOPs may be warranted.

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