Business owners facing an ownership succession decision face a number of questions in selecting an appropriate buyer. Frequently, as business owners become acquainted with the unique benefits of selling their company to an ESOP, questions emerge pertaining to feasibility and the characteristics of a good corporate candidate.
Companies that generate consistent or increasing earnings are good candidates. At its core, selling a company to an ESOP is a tax-advantaged way to facilitate a leveraged buyout (LBO). As is the case with any LBO, a concern is the post-transaction ability of the company to repay the debt incurred to finance the transaction. Companies that generate consistent or increasing earnings are better suited for an LBO relative to companies with volatile earnings or whose earnings are in decline.
Statutory requirements governing ESOPs limit the amount of stock benefits that can be concentrated in the hands of only a few individuals. Sole proprietors or small, local shops and businesses with only a handful of employees lack an employee base sizable enough to meet statutory requirements. A company that is sizable enough to meet statutory requirements is a good candidate.
A business owner desiring fair market value, and wanting to preserve a company’s operational structure post-transaction is a good candidate. An ESOP is a financial buyer that can pay fair market value, but not strategic value. Strategic buyers are usually able to pay the highest price due to their ability to generate cost savings through integration, which may include facility closure and employee layoffs. For many business owners, maximizing price while negatively disrupting the employees, communities, and values that built the business is not a desirable outcome.
A business owner not wanting to sell to private equity is a good candidate for an ESOP. As a shorter-term financial buyer, private equity firms are ultimately interested in generating a return on investment through a secondary sale of the business. To that end, the private equity firm may seek active oversight of a company’s operations in the intervening years. For many business owners, active oversight of management, restrictions on the business, and the resulting disruption to employees and management in pursuit of an inevitable secondary sale of the company, is not a desired outcome.
Business owners seeking a partial sale are good candidates for an ESOP. In most cases, strategic buyers and private equity firms are only interested in a change of control transaction. An ESOP is a unique buyer in that it can afford a business owner the opportunity to diversify personal wealth tied up in a corporation through the sale of only a portion of the company. Further, business owners selling at least 30% of a company may be eligible to defer capital gains taxes on the sale.
While selling to an ESOP may not be the ideal solution in every circumstance, it certainly should be considered along with other options. Since the characteristics of a company can impact the feasibility of selling to an ESOP, it is important to seek the help of professionals experienced in the use of ESOPs to facilitate ownership transition.