Workers’ Stock = Your Exit?

Every owner looks for the best way to retire from a beloved business. One employee incentive may be your best answer: employee stock ownership plans (ESOPs).

These qualified retirement plans must invest primarily in the stock of the sponsoring employer. If you master its intricacies, an ESOP might be a good decision for you and your employees.

Elements to consider:

Best scenario. An ESOP works best for a selling owner who developed a good management team and who wants to make sure that the business continues. (If you sell your company to a third party, your company will almost certainly become a different animal very quickly.) An ESOP also does best for companies with more than 50 employees and more than $5 million in annual sales.

ESOPs are generally too costly and complicated for small companies. Also, small companies tend to not develop management structures and training programs to bring the next level of managers along.

If your managers don’t want to share ownership with all employees, an ESOP might not be a good idea for you. If you don’t favor sharing information with your employees or you don’t care what happens to your company after you leave, don’t bother with an ESOP.

Cost. Well-structured ESOPs often cost $150,000 to $250,000 to set up. Professionals from ESOP organizations tell me the process can cost less – true, and often with shortcuts that can come back and bite you.

Compare an ESOP’s cost to what an investment banker might charge you to sell your business. If the enterprise value of your company is at least $5 million, an ESOP costs no more than hiring an investment banker. If the value of your company is less, you might decide an ESOP is not for you.

Taxes. An ESOP can be an attractive way of leaving your business – and an even more attractive way to run a business. For one, if your business becomes an ESOP and converts to a Subchapter S (giving a corporation with 100 or fewer shareholders benefits of incorporation but the lower tax rate of a partnership), the ESOP-owned portion of the business pays no income tax.

If you’re a seller, you can also structure the sale to avoid paying taxes on your proceeds. At the very worst, you pay capital gains taxes only.

Guidelines. Here are eight considerations:

1.      Start with the ESOP owning a small part of your company, such as 30%. If the deal fails, you can unwind more easily.

2.      Make sure you like – and your employees are comfortable with – open book management in which all staffers share access to financials and other information. ESOPs are not required to share numbers but those that do tend to perform better.

3.      Make sure your managers favor an ESOP. Sometimes managers want to own the company without rank-and-file employees sharing in the gains and losses.

4.      Be confident that your company’s future is bright. These plans can be a real boon to employee morale, but if the company hits a rough spot the value of ESOP ownership goes down, potentially damaging employee morale.

5.      A well-designed ESOP is expensive in part because good professionals are expensive. Still, a pricey but good team likely saves you money in the long run.

6.      Learn your options. A trade group called the ESOP Association has many local and national meetings that offer sessions for companies considering an employee stock plan.

7.      Talk to others who did ESOPs. What didn’t they like about the process and the plan and what would they do differently?

8.      Take your time. This big decision has lots of twists and turns. Truly understanding your stock plan options pays off in the end.

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Josh Patrick is a founding principal of Stage 2 Planning Partners in South Burlington, Vt. He contributes to the NY Times You’re the Boss blog and works with owners of privately held businesses helping them create business and personal value. You can learn more about his Objective Review process at his website.

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