ESOPs as a path to succession planning and liquidity
By Jonathan Skelly -- Industrial Distribution, 12/6/2007 8:08:00 AM
Succession planning has become a key issue facing family- or privately-owned distributorships. Often, entrepreneurs view the sale of their company to a strategic buyer as the best way to bridge the succession gap and create a liquidity event. While a sale to a strategic buyer is a viable strategy, it is not the only alternative. Another compelling option for business owners to consider is an Employee Stock Ownership Plan (ESOP).Technically an ESOP is a qualified, defined contribution employee benefit plan that invests primarily in the stock of the employer. Practically, it’s simply a tax-advantaged way to sell a business. A sale to an ESOP has several advantages compared with a sale to a strategic buyer:
• It is a highly flexible liquidity strategy that allows the owner to specify and control the most important issues in a transaction; the owner can also sell only a portion of shares versus a controlling stake;
• There are compelling tax advantages both to the company and the selling shareholder(s);
• The owner can retain operational control of the business and/or transition management at the time and pace desired;
• The ownership that the employees gain is a gift, created by the tax savings associated with the ESOP.
ESOPs provide a host of operational advantages. Specifically, the ESOP allows the owner(s) to retain operational control and the culture they have built while grooming and positioning the next generation of management after the owners have realized a full or partial liquidity event. And the offer of company ownership is a powerful tool to attract management talent to the company.
Furthermore, ESOP shares are essentially a gift to the employees that serves as a potent means of motivation and retention. Examples of ESOP-owned companies that are well known in the distribution industry include Border States Electric and Bradford White.
In addition to operational advantages, the tax advantages of an ESOP are significant. For example, most strategic sales are structured as asset purchases, creating an effective blended tax rate of approximately 25 percent; an ESOP sale is a stock sale taxed at the 15 percent capital gains rate.
Furthermore, business owners that sell shares to an ESOP are able, in certain situations, to defer or eliminate capital taxes entirely. Going forward, the company could experience meaningful tax savings because an ESOP enables a company to shield meaningful portions, if not all, of its earnings from taxes.
ESOPs obviously are not the best fit for all owners in that they require management to stay active and create heightened fiduciary responsibilities. For owners seeking a 100 percent sale and near-term retirement, a strategic sale will continue to make the most sense.
But for an owner seeking to create an ownership culture and develop and motivate the management team of the future, while taking some of the value of his/her significant investment in the business out of the company, an ESOP is an option that should not be ignored.
Jonathan Skelly is an investment banker with PCE Investment Banker of Orlando, Fla. An investment bank for mid-market companies, PCE’s practice areas include distribution, aerospace & defense, ESOP, health care, construction & homebuilding, manufacturing and food.
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