by Corey Rosen and John Case, co-authors of “Ownership: Reinventing Companies, Capitalism, and Who Owns What“
If you own a thriving, profitable company — and if it’s big enough to survive your departure — you have a valuable asset on your hands. If and when you decide to sell the business, you’ll have prospective buyers lined up at the door.
It can be a confusing time, just because there’s so much at stake. There’s the money, of course: you want to capitalize on the years of investment and hard work you’ve put in. The selling price is a factor. So are the terms of payment and the likely tax burden — all variables to consider.
There’s also the issue of the company’s future. What will happen to the business? Will your loyal employees lose their jobs? If the company is swallowed up by some giant conglomerate or bought and then sold off by a private equity firm, the effect on both workers and the local community could be devastating.
Finally, there’s that intangible factor known as legacy. Maybe your name is on the door. Maybe you have built a company — and a reputation — that you hope will live on for a long time.
Who’s on your short list of buyers?
Chances are you already are familiar with most of the possible buyers. Large corporations or competitors — so-called strategic buyers — may want to acquire your business, perhaps hoping to incorporate it with their own operations. Private equity firms might hope to buy your company, boost its profitability, and then resell it or take it public a few years later. An internal management team might want to pursue a leveraged buyout.
Most business lawyers and accountants are familiar with buyers like these and can help you sort through the possibilities.
But there’s one option you and your advisers may not know about: selling the company to your employees through an employee stock ownership plan, or ESOP. For many companies — not all — this option turns out to be far and away the best choice.
What ESOPs bring to the table
First of all, let’s dispel some myths. ESOP sales aren’t some far-out, fringe idea. They’re used by hundreds of companies every year. Several thousand U.S. businesses are owned, partly or wholly, by their employees through an ESOP. And these companies outperform their conventionally owned peers.
Nor do your employees have to come up with any money. In an ESOP, workers don’t buy the shares with their own funds; most couldn’t afford to do so anyway. Instead, the shares are paid for (on a tax-deductible basis) from the company’s future profits — profits that the employees help the company earn.
Selling to an ESOP also doesn’t mean the company is suddenly going to be run by all the workers, town-meeting style. Most ESOP companies operate just like any other business, with a board of directors and an appointed CEO. The only difference is that employees enjoy the financial benefits of ownership, such as an increase in the value of company shares over time. The longer employees stay with the company, the more shares they’re typically awarded.
ESOPs have been around for a while now. They’re regulated and approved by the U.S. government. ESOP companies pay lower taxes than conventional businesses, not because of some sharp accounting practices but because the law allows them to do so. Congress has repeatedly passed laws to encourage this kind of employee ownership.
From an owner’s perspective, selling to an ESOP has major benefits. The company operates just as before, and everyone keeps their jobs. If you’re not ready to retire, you can continue to run things. Moreover, the government lets you defer capital-gains taxes on the proceeds of the sale, provided you sell at least 30% of the shares to the ESOP and invest the proceeds in other U.S. stocks or bonds.
So, here’s how to know whether an ESOP is worth exploring:
Legacy and fair treatment are important to you.
You’d like the company to maintain its independence. You’d like your employees to be able to keep their jobs, and you’d like to reward them with equity in the company they helped build.
You can live with a slightly lower sales price, if necessary.
When an owner sells to an ESOP, the company’s fair market value — the sale price — is determined by a third-party appraiser. In a minority of cases, a strategic buyer or private equity firm may offer to pay more, but you have to factor in the ESOP’s tax benefits to get a true apples-to-apples comparison.
You don’t mind taking back a note for part of the price.
Banks won’t finance 100% of an ESOP transaction; owners who sell to all the company in a single ESOP transaction are usually paid a portion of the sale price over time. It’s the company that pays the note, not the employees.
Business advisers, like lawyers and accountants, don’t always understand the benefits of an ESOP. If yours scoff at the idea, find advisers who know what they’re talking about. Meanwhile, read up on ESOPs — the National Center for Employee Ownership can help you get started. It’s the best way of ensuring that the company you’ve built lives long and prospers.
Corey Rosen, Ph.D., is the founder and senior staff member of the National Center for Employee Ownership. He writes frequently on employee ownership and serves on several ESOP company boards. John Case is a veteran observer and analyst of the business world and a nationally known writer on business and economics. Their new book is “Ownership: Reinventing Companies, Capitalism, and Who Owns What“.