Six reasons an ESOP might be right for your business

By Elizabeth Di Cola, Managing Director, ESOP Finance Group

Find out about the benefits –  financial and non-financial – of an ESOP.

A business owner can benefit financially from selling his or her business to employees using an employee stock ownership plan (ESOP) structure. Using an ESOP for ownership transition can achieve significant non-financial benefits as well. Discover six reasons this structure may be the right solution for your business.

1. If you would prefer to sell only part of your business
One advantage of an ESOP is the flexibility an ESOP structure provides. Unlike a sale to a private equity firm or a strategic buyer, a sale to an ESOP doesn’t have to be an “all or nothing” proposition. An ESOP can be used for a partial exit — an option that may be very useful in a variety of situations, including:

  • A younger generation uninterested in or unable to assume full ownership, or a split between those who want to be part of the business and those who wish to be bought out
  • Divorcing couples who are joint business owners
  • The need to create liquidity to compensate owners who are ready to leave the business, while not undermining the foundations of the company or forcing a sale by those who wish to remain involved

2. If your legacy is important to you
Some people close the door on a business and that’s the end of it for them. Get the best price possible, and ride off into the sunset, looking forward to enjoying all the things they didn’t have time for while building their business.

For those who see that transition differently, an ESOP can be a more attractive solution. An ESOP enables your employees to become part of your legacy. It allows you to keep your name on the door and continue to participate in — and guide — the running of your company. For example, if you are a major employer in your community, providing economic vitality, jobs and opportunity to the area, there is no “outsider” who could decide to move the operation to another city. Or if you were an innovator in improving the employment conditions in your office or plant, an ESOP may afford you the opportunity to maintain and possibly expand those innovations.

If you’re looking to create more space in your life for non-work activities, but still want to make the most of your energy and expertise with regard to your business, an ESOP can be structured to allow you to do just that.

3. If you’d like to recruit and retain your best workers
Recruiting and retaining people is one of the biggest hidden costs for any company, especially in very competitive markets. Being able to offer potential employees a piece of the business can be a powerful recruiting tool, compensating for an inconvenient commute or location, or differences in medical benefits. An ESOP can even be structured to include contract workers, giving the business a real leg up in competing for talent. Having a real stake in the business is a benefit that isn’t available in all companies, and certainly is seldom available to non-full-time employees.

Likewise, transitioning to an ESOP can help you retain valuable employees, providing a financial benefit to the owner beyond the increased liquidity and tax advantages. In fact, studies show that employees who have “skin in the game” feel greater loyalty to their company and exhibit a higher level of productivity.

4. If you want to maintain a sense of control
Another way an ESOP can prove to be a more flexible alternative to a third-party sale is that it allows the owner to create a platform from which to continue to provide advice and guidance. The liquidity provided by the sale to employees allows you to diversify your holdings while continuing to participate in the leadership of the business. If you wish, you can continue to participate with your senior management team in making decisions and providing leadership. You can remain actively involved in your company’s future — within the bounds of good corporate governance and Employee Retirement Income Security Act (ERISA) fiduciary rules.

5. If you face difficulty in finding a market for your business
Not all businesses lend themselves to a sale to an outside investor or to being absorbed by another firm. Professional services firms — such as architecture, engineering, marketing and staffing companies — often fall into this category. When faced with a situation like this, an ESOP can be a way for an owner to tap into the valuable brand he or she has built.

After all, who is better equipped to take over than the employees you helped mentor and who were instrumental in giving that business its distinctive edge? Transitioning to an ESOP allows a company founder to enjoy a well-deserved retirement while demonstrating ongoing involvement to the company’s clients.

6. If you’re concerned about your business weathering economic downturns
ESOP companies have shown surprising resilience even when the economy as a whole is facing problems. A 2010 study conducted by Phil Swagel of the McDonough School of Business at Georgetown University tracked the performance of companies owned by S-Corporation ESOPs and showed that even during the first year of the recession of 2008, they were adding employees and seeing double-digit growth. 

A different study compared 1,100 ESOP companies and 1,100 non-ESOP companies over the course of a decade. Conducted by Joseph R. Blasi and Douglas L. Kruse, professors at the School of Management and Labor Relations at Rutgers University, the study's results showed that ESOPs increase sales and employment between 2.3 percent and 2.4 percent. ESOP-owned companies in the study had a business survival rate of 77.9 percent compared to 62.3 percent for non-ESOP-owned companies.

In conclusion
For business owners who are interested in moving on, but have felt stymied by any of the above considerations, an ESOP provides a flexible alternative to a sale to a financial or strategic buyer. As with any endeavor of this kind, such a transition requires a great deal of preparation and a team of professionals with expertise in the creation of ESOPs. But the benefits go beyond financial liquidity and tax advantages to preserving your vision for your company.