The Pro’s and Con’s of ESOPs
Scott Nelson, Partner
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.
- 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
- 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.
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