Use an ESOP to Transfer Ownership of Your Business
November 27, 2019
At a glance
- The main takeaway: With an impending retirement wave on the horizon, more businesses will be looking for viable strategies to ensure a smooth financial transition between successors.
- Impact on your business: Employee stock ownership plans (ESOPs) are efficient financial vehicles that can help you transfer assets efficiently and cost-effectively, while also boosting employee morale.
- Next steps: Aprio’s Retirement Plan Services Team can help you assess whether or not the ESOP is a viable addition to your succession plan.
The full story:
As baby boomers prepare for and settle into retirement, businesses across the country are on the brink of major transitions in leadership. In fact, according to Guidant Financial and LendingClub’s Report on the State of Small Business, more than half of small business owners are age 50 or older.
Many owners use financial vehicles like employee stock ownership plans (ESOPs) to help facilitate ownership transfers to successors. Here are a few key considerations to keep in mind when debating whether or not to set up an ESOP.
Why consider an ESOP?
As you think about retiring and exiting your business, one of the most important steps to take is to develop or review your succession plan. Although many owners look to sell their businesses outright, an ESOP offers another solution. ESOPs are qualified retirement benefit plans — similar to 401(k) plans — that give employees an ownership interest in the company. ESOPs are funded by tax-deductible contributions by the employer in the form of either company stock or cash; that contribution is used to purchase company stock.
Aside from helping streamline ownership transfers, ESOPs also have an intangible benefit: company morale. Since the company’s employees also are part owners in the company, they have a vested interest in seeing the company succeed. Ownership-based cultures tend to boost employee satisfaction and retention.
ESOPs operate through a trust or other named fiduciary, which means that the administrative costs can be high. Other associated costs can be high as well. For example, the process of setting up an ESOP usually starts with a feasibility study conducted by an outside consultant. This study will include a business valuation, an analysis of the company’s cash flow and debt capability, and a suggested structure for the ESOP. It’s important to keep cost effectiveness and your own budget in mind when deciding if you should establish an ESOP.
Is an ESOP right for you?
Even though there is a long list of benefits that come with ESOPs, not all businesses should consider them as a succession strategy. ESOPs work best for companies with:
- Annual payroll of at least $1 million
- At least 20 employees
- A solid management team
- Strong cash flow
- Debt capacity
A critical step in implementing an ESOP
If you determine that an ESOP is a good option, and you and your co-owners (if applicable) agree with the terms and suggested structure, you need to identify a trustee. The trustee will hire a valuation firm to oversee the terms and issue a fairness opinion. This opinion will focus on the financials of the deal. Once everything is agreed to, both the company and the trustee will need legal counsel. The associated expenses may be high, but the tax savings for ESOPs can be substantial. For example, a business owner who sells more than 30% of his or her company to an ESOP may be able to defer any capital gains tax by rolling over the proceeds to a qualified investment. No tax would be due until those investments are sold.
The bottom line
ESOPs can be an excellent option for business succession, but there are many factors to consider before you can decide whether they are a good fit for your company. Aprio’s Retirement Plan Services Team can help you assess whether or not the ESOP is a viable addition to your succession plan.