There are many benefits to selling a company to an employee stock ownership plan (ESOP), including wealth creation for the employees and tax benefits and liquidity for the selling shareholders. Numerous studies conducted by organizations such as the Employee Ownership Foundation cite that employee-owned companies experience increased profits, overall productivity and stock value. As an ESOP-owned company matures, however, attempting to grow the business may present a different set of challenges along the way. Management teams and boards of directors of ESOP-owned companies should consider repurchase obligations as they strategize for long-term growth in order to achieve similar results.
When structuring and funding an ESOP, the company’s leadership and its advisors should examine the ESOP from a corporate finance perspective to ensure that the ESOP supports the company’s overall growth strategy.
ESOP-owned companies lacking thorough analysis prior to the transaction will likely experience capital constraints. Repurchase obligations create a constant need for capital and can divert capital from productive uses to unproductive uses, thereby preventing the company from pursuing the highest and best use of cash. Without an efficient capital structure to support participant payouts, an ESOP-owned company may not be able to pursue important growth initiatives such as moving into new markets and geographies, developing new products, providing improved resources to the staff, investing in sales and marketing, or growing through acquisitions.
Some companies struggling with repurchase obligations may choose to exit from the ESOP structure. Many companies, however, should first pursue alternative options to maintain employee ownership while accomplishing their goals for ongoing growth.
A mature ESOP company may find itself with substantial repurchase obligations that are directly at odds with growth opportunities, which could occur when a significant percentage of the plan participants are former employees who no longer contribute to corporate growth. Recapitalizing the company can address this issue.
Optimizing the capital structure can drastically impact an ESOP company’s ability to fund its repurchase obligations, without forcing the company to exit from the ESOP structure entirely.