An Employee Stock Ownership Plan transaction, or ESOP, also known as Stock Purchase Plan, or SPP, can maximize after-tax returns to sellers of a business and also helps to make the business more competitive, productive and attractive to high-value workers. Here are enumerated 6 reasons why selling to an ESOP can be the best for your company:
If your company is a C-Corporation entity and it is sold, capital gain taxed paid to the federal and state governments can reduce sale proceeds by 23.5% or more (33.3% in California). Selling to an SPP allows the owner to potentially defer those taxes forever by re-investing the proceeds in qualifying securities, such as stocks and some bonds. The obvious result will be evident-after-tax proceeds of $100 million vs. $67-to-$76 million.
Many owners selling to an ESOP remain invested in the company through warrants (structured equity). Thus, they retain an interest in the future prospects of the business. Considerable research shows that employee-owned companies outperform competitors operating under other ownership formats, the main reason being the employees acting like owners. Waste is reduced as is friction between workers and management. Productivity rises and worker-generated ideas for improvement bubble up.
In this case, the S-Corp business doesn’t have to pay federal or most state income taxes. Thanks to legislation designed to encourage employee ownership. Employee-owners pay taxes when they withdraw their stock upon retirement or only on leaving the company, much like an IRA or 401(k). This enhances cash flow and allows S-Corp ESOPs to invest even more in growth. They make acquisitions and pay down debt taken on to form the ESOP. Because of this tax benefit and other factors, many former C-Corp ESOPs are getting converted to S-Corp and some smart private equity firms are gaining interest to invest alongside ESOPs.
Perhaps your name is on the building and your company is a valued corporate citizen in your community. A strategic buyer (competitor) might realize the greatest value by shutting down your operation, laying off your employees and shifting customers to his existing business. This pattern can occur in private equity deals too. ESOPs can preserve and indeed enhance your business’s legacy with employees, customers and communities, by enabling independence and financial well-being.
Buyers attempting to withhold due money from a seller based on earn-out and other provisions of a sale agreement are on the rise with buyers attempting to set aside ever-enlarging percentages of the sale price as contingent compensation. Post-Closing disputes are far less common among SPP companies. Buyers and sellers essentially know one another. The seller often remains active and invested in the business. Distrust isn’t automatic.
A recent study of S-Corp ESOPs conducted by EY’s Quantitative Economics and Statistics Practice (QUEST) found that they vastly out-performed the S&P 500 during the years 2002 to 2012. The employees who otherwise may not save anything for retirement often wind up retiring comfortably and with dignity.
About The Author
- Mary Josephs
- CEO, Verit Advisors
Mary Josephs is the Founder and CEO of Verit Advisors. A nationally recognized leader, Ms. Josephs comes to us with more than 28 years of experience with ESOPs as a specialized solution-oriented succession and liquidity transaction for middle market companies.