The Pros and Cons of ESOPs

The Pro’s and Con’s of ESOPs

Scott Nelson, Partner

B2BCFO

Minneapolis, MN

There are many things to consider when you start to think about selling your business. Some of those include; How much is my company worth? How long will it take to sell? What will I do after I sell it? But probably the most critical question to answer is, Whom do I want to sell it to?

There are a number of different options such as; a strategic buyer, management buy-out, private equity, financial buyer, etc. and each one has different costs and benefits. Deciding on which one really depends on your goals and objectives for selling your business.

One option is to sell the company to the employees by creating and Employee Stock Ownership Plan (ESOP). ESOP’s have become a hot topic these days. It can be a great exit strategy in the right situation and a great benefit for the employees. However, there are a number of pros and cons about becoming an ESOP that you should be aware of. So what are some of the pros and cons you ask? Here is a list that is not exhaustive but will give you a few things to think about.

Pros

Significant tax advantages
Owner(s) can participate in the ESOP (S-Corp only)
Flexible and friendly transaction
Management stays in place
Aids in recruitment of new employees
Employees participate in the increased value of the company
ESOP companies statistically perform better than other companies

Cons

Seller(s) may not get top dollar for the company
Seller may have to carry some debt
Ongoing annual administrative, valuation & trustee fees
Additional expenses incurred to set up
Significant planning needed for repurchase of shares from retiring or terminated employees
Negative impact of a decrease in valuation on employee morale
Financing issues due to the increased debt of the company to purchase the shares

Becoming an ESOP can have tremendous advantages for both the business owner(s) and the employees. However, a great deal of research and soul searching should take place before making that decision. The owner(s) should clearly understand what their goals and objectives are for selling the business and for their life after the sale. The business owner(s) should also consult with a number of trusted advisors such as, accountants, lawyers, wealth managers, etc. before making any decisions.