Sale to an ESOP compared to other exit strategies
Business owners interested in selling their company are usually aware of the traditionally familiar exit strategies: sell to a strategic buyer, or sell to a financial buyer. Unfortunately, too few business owners are aware of yet another alternative: sell to your employees via an Employee Stock Ownership Plan (ESOP). Each of the three alternatives has its own pros and cons. Business owners would be wise to make sure their advisors present all alternatives for consideration to insure that they are making an informed decision based on complete information
Selling your business to a strategic buyer usually yields the highest “gross” price. Of course, the “net” price received is dependent on the seller’s applicable tax rate. Strategic buyers are usually able to pay more than any other buyer because of their ability to generate synergistic savings. Synergistic value is usually created by making significant changes to the business that will yield cost savings, including facility closure and consolidation with existing buyer facilities, layoffs of duplicative employees, etc. For many business owners, negatively disrupting the employees, communities, and values that built the business is not a palatable outcome.
Selling your business to a financial buyer (i.e., a private equity firm or wealthy individual) usually results in receiving fair market value, but not synergistic value. Again, the “net” price received is dependent on the seller’s applicable tax rate. Financial buyers are generally investors that are not able to generate synergistic value. However, given that most investors are ultimately interested in selling the business at a profit after a relatively short hold period, many investors will seek active oversight of the operations of the business to insure earnings are being maximized quickly. As a result, investor groups may restrict operations in an effort to maximize growth and profit. The demanding criteria for maximizing profit may result in unappealing cost savings initiatives, including facility reconfiguration, salary reductions, and employee layoffs. For many business owners, active oversight of management, restrictions on the business, and the resulting disruption to employees and management from the initial sale and the inevitable secondary sale of the company, is not a palatable outcome.
Selling your business to an ESOP usually results in receiving fair market value, but not synergistic value. Again, the “net” price received is dependent on seller’s applicable tax rate. However, favorable tax regulation providing tax deferral elections to business owners selling to an ESOP means the “net” price could potentially be the same as the “gross” price. In other words, there would be no tax due on the sale. Further, significant tax savings may also inure to the company as a result of prevailing statutory regulations providing tax deductions and exemptions to ESOP owned companies. In general, an ESOP is a trust that is established for the benefit of employees. Employees receive an economic interest, but not an ownership interest, in the company. Selling to the employees via an ESOP Trust is akin to a management buyout, and results in little to no negative disruption to employees, communities and corporate values. In fact, selling to an ESOP is often a positive event. Employees have an economic interest in the success of the business and are, therefore, motivated to minimize waste, work more productively, and pursue initiatives that increase company earnings and value.A vested interest in the economic success of the company can be a powerful employee recruiting, retention, and motivational tool.
Due to the statutory requirements governing the tax benefits afforded to an ESOP, it is important to seek the help of professionals experienced in negotiating and structure ownership transition using an ESOP to insure the benefits of the tax savings are fully realized.
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