Employee Stock Ownership Plans
Founders and owners of privately held, lower-middle market companies face vexing challenges when it comes to developing optimal, holistic business succession strategies. The risks associated with passing on such companies are real and legion. Owners and founders are often left feeling overwhelmed and ambivalent about relinquishing control and/or selling, despite knowing a major change is just over the horizon.
Employee Stock Ownership Plans - ESOPs - can provide the unique solutions often required by these low-middle market companies facing succession hurdles. While the nuances of these qualified plans can seem daunting, their inherent breadth and flexibility enhance their utility in many situations and provide an elegant, intermediate step which neither requires giving up control today nor forfeiting the opportunity for a complete sale in the future.
Of course, the traditional M&A process, more realistically available to companies with $3MM+ of EBITDA, can be the path of least resistance and offers the optimal choice for many owners. If maximizing cash is the primary objective, and the markets are favorable, engaging in a formal sales process is clearly the superior alternative.
An ESOP, on the other hand, can provide a ready and steady buyer of company stock, in any amount, in any market condition, whenever a seller decides to sell shares. As a qualified plan, an ESOP can be established and sit alongside a 401(k) plan, effectively being prefunded in anticipation of an owner wanting to begin selling shares sometime in the foreseeable future. Cash accumulated in the ESOP will ultimately be used to buy shares and, if and when it makes sense, can be supplemented by a loan from the company. Both the principal and the interest on a loan to the ESOP can be deducted as they
are treated as any other contribution to a qualified plan.
Importantly, because employees are simply participants in an established ESOP trust, they do not exercise regular share voting rights, which are usually controlled by the ESOP fiduciaries of private companies. Additionally, participants are not required to receive company financial statements and only receive limited financial information through an annual benefit statement showing their number of shares and the fair market value of those shares.
Succession planning and execution can be a complicated, time-consuming and worrisome process. However, with the right planning and tools, businesses can be passed on successfully. If yours is a profitable company with at least 15 employees and more than $1MM in revenue, in any industry other than professional services (physician-owned medical practices, law firms etc.), regardless of whether you are a C-Corp or an S-Corp, establishing an ESOP can be a relatively cost effective, tax efficient and elegant solution to the business succession dilemma facing many founders and owners of lower-middle market companies. Exploring the possibilities may well be worth the time and effort.
About the author:
William Stewart, Director, Client Advisor of Alex. Brown | Raymond James is a member of Banyan Partners, a team focused on helping founders and owners of lower middle market companies, and their families, successfully navigate the challenging arc of company transformation and personal transition. He can be reached at william.stewart@alexbrown.com or by phone at 443-214-7751. Banyan Partners’ website is www.alexbrown.com/banyanpartners.
This material is being provided for informational purposes only and is not a complete description, nor is it a recommendation. While we are familiar with the tax and legal provisions of the issues presented herein, as Financial
Advisors of Raymond James, we do not provide tax or legal advice. You should discuss tax or legal matters with the appropriate professional.