What happens when a business owner finds:
- No one in the family wants to take over the business.
- Market conditions just aren’t right for selling the business.
- The business represents just about all of the owner’s personal net worth.
- All of the above.
If a business owner chooses one or more of the above options as familiar to their business conditions, an option to consider in succession planning is an Employee Stock Ownership Plan (ESOP).
Defined as a method of privatization allowing employees to take over or participate in the management of the organization that employs them by becoming shareholders of stock in that organization, ESOP organizations receive significant tax benefits, as do plan participants and the selling shareholders.
ESOPs allow business owners to sell all or part of their company and, if they desire, to remain in control for as long as they want. Additionally, an owner who does a partial sale to an ESOP has many options, including:
- Keeping ownership at the same percentage.
- Increasing ESOP ownership through a future sale.
- Reducing the ESOP through stock re-demptions as employees leave.
- Bringing family members into the business and giving them ownership and/or control.
- Selling the entire company including the ESOP to a third party, possibly at a later date.
Added to that, studies show productivity and profitability improve after an ESOP has been implemented. This is believed to be due to the employees’ sense of ownership.
An employee’s ESOP account is similar to an IRA, profit sharing or 401(k) account. While the stock is in the ESOP, it grows tax deferred. Upon distribution the employee may continue to defer taxes by either rolling over these funds to an IRA or transferring them to another qualified retirement plan.
If the corporation is a C corporation and the shareholder sells 30 percent or more of his or her stock, the owner can defer indefinitely the taxation of his or her gains on the sale of the stock.
If the company is an S corporation, rollover is not allowed. However, if all the stock is sold to an S corporation ESOP, the future earnings of the company will be exempt from income tax.
Selling a company to the employees through an ESOP may be the perfect exit strategy. It might even launch a growth curve. Of course, with any financial decision of this magnitude, it is advisable to check with a professional financial planner.