ESOPs are an attractive option for owners looking to exit a business. An ESOP transaction can provide tax and other advantages for the company. An ESOP can boost recruitment and employee retention, and drive business growth by providing incentives to the company’s management team in the form of future equity or pseudo equity participation. ESOP transactions also offer certain advantages for the selling owner, including
- Flexibility in deciding how much of the business to sell and when;
- A fair market value price for the business;
- The preservation of founder legacy and company culture;
- The ability to exit the company gradually over time to provide a period of transition for the next generation of leaders;
- Continued operational control over the company, since the company’s board of directors and management team will continue to run the company even when the ESOP owns a majority of the stock;
- The possibility of receiving warrants in the transaction in lieu of cash pay interest on seller notes. Warrants would allow the selling owner to benefit from a future increase in the company’s value, and are taxed at capital gains rates upon exercise.
Not all businesses are ideal candidates for an ESOP. The right types of businesses for an ESOP are usually those with a strong track record of profitability and a stable, engaged workforce. Because ESOPs require significant administrative overhead and a long-term commitment to employee ownership, they are typically best suited for companies with at least 20 employees and at least $1 million in annual profits.
In addition, ESOPs are often a good fit for family-owned businesses looking for a succession plan. Because ESOPs allow for a gradual transition of ownership, they can provide a smooth, tax-efficient exit strategy for family business owners.