When an owner of a privately held company is planning to retire, there are many different ownership transition options from which to choose. Examples include a management buyout, transfers to the next generation, sale to a third party buyer, IPO, or even liquidation. Each of these options has pros and cons, which should be evaluated based on each business owner’s unique situation.
One option that business owners are typically less familiar with is an Employee Stock Option Plan (ESOP). Using an ESOP as an exit strategy can be an effective way to meet many transition goals and provide for the long-term success for the organization which the departing owner spent so much time building.
Benefits of an ESOP go beyond just providing a tax-efficient liquidity event for the owners. Owners of privately held or family-owned business are often looking for much more than a large payday when they exit their companies. They want to know that their employees and their customers will be taken care of, and that the legacy they worked so hard to build will live on. When selling to a third party buyer, owners often can’t be sure what will happen once they walk out the door. An ESOP can help reduce that uncertainty.
Some business owners also agonize over the thought of selling their business and “putting it on the market.” The entire process can not only be stressful, but can also be a distraction to the entire company. ESOPs, on the other hand, are often referred to as a “friendly buyer.” Unlike going out to market and having to negotiate with a third party buyer, valuation in an ESOP transaction involves a third party valuation firm that helps determine the overall fairness of the proposed transaction. If the value is acceptable to the owner, then the lawyers prepare all required documentation and the transaction proceeds to closing. The overall process can be controlled and is much less disruptive to the company.
In addition, many owners have difficulty with the concept of handing over the keys to the company in one shot, and prefer the opportunity to gradually transition ownership to employees. An ESOP can provide a succession strategy that allows an owner to move tranches of equity to the ESOP over time, transition their role from CEO to board member, and eventually to full retirement.
Finally, in some situations, family-owned businesses are passed down from generation to generation, but eventually reach a point when the next generation is not willing or able to take over the reins. An ESOP not only maintains the legacy of the departing owner and the family, but it also rewards the employees who helped create that very same legacy.
When starting to plan for an ownership transition, it is wise to consider the pros and cons of each option and how they impact both the business and the exiting shareholder. An ESOP can provide unique advantages that may not be available through other exit channels, and in some cases the intangible factors associated with ESOPs can outweigh the benefits of those other exit paths.
You may also like: