ESOPs or Employee Stock Ownership Plans should be considered as a succession tool by business owners.
When business owners first start to consider the possibility of retiring or transitioning away from day to day operations, many look around them to see who might be a potential buyer. A family member or a friendly competitor or an allied business frequently often come to mind. But perhaps owners should consider their employees as potential buyers.
An ESOP is an Employee Stock Ownership Plan. In the right circumstances, ESOPs can be a great succession planning tool. ESOP’s receive extremely favorable tax treatment. But they are not suitable for every situation and can be somewhat complex and costly.
They often work well if an owner wants to stay involved but obtain asset diversity by selling perhaps 1/3 of the business. There are strong tax advantages. When set up properly both the loan principal and interest is deductible for tax purposes. Note, usually only loan interest is deductible for tax purposes. This is a huge advantage.
An ESOP may be set up with existing cash from the plan sponsor’s balance sheet but are usually leveraged.
- The loan may be from a bank or other financial institution or the selling shareholder may finance the transaction by taking back a note for part or all of the purchase price
- The plan sponsor usually uses its balance sheet to secure the debt financing
- Often the owner must guarantee to loan to the business. Sometimes this guarantee can be limited in time and amount.
The ESOP borrows the money to purchase company stock (outstanding shares, new shares, or treasury shares) which is held in trust for the benefit of the employees.
- The company makes tax-deductible contributions to the ESOP to enable the ESOP to repay the loan
- As the loan is repaid, shares held by the ESOP are released and allocated to employee accounts
- The employee shares are held in trust.
More information about ESOP options can be found at National Center for Employee Ownership or connect with Harvest Business Advisors to discuss your options – email firstname.lastname@example.org or call 877-838-4966.
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Harvest Business Advisors provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at email@example.com or 877-838-4966 to discuss selling your business, ordering a business valuation or buying a business.