Succession planning? Don’t overlook your employees as an option.
For many business owners, succession planning is about more than getting the best price.
You may have spent decades building a company, developing a strong team and creating jobs in your community. You know your employees and their families. In many of the markets we serve, business owners see their employees at the ballfield on Saturday or church on Sunday.
When it comes time to step away, you have a lot to think about. What happens to those employees? What happens to the culture you built? Will the company still be there in 10 or 20 years?
Those questions are one reason an employee stock ownership plan, or ESOP, may be worth considering.
Start with all your options.
Owners have several ways to transition a privately held business. You might sell to a strategic buyer or private equity firm. Your management team may be able to buy the company. You might also sell some or all of the business to an ESOP.
An ESOP is a qualified retirement plan that is designed for the benefit of employees. In a typical ESOP transaction, a trust is created to purchase shares from the current shareholders. The trust then holds those shares on behalf of employees who participate in the plan.
For an owner, that can provide a path to liquidity without selling the company to an outside buyer.
For employees, it provides an opportunity to build retirement wealth as the company succeeds without having to purchase the shares themselves.
Think about what you want to preserve.
I often find that an owner’s initial interest in an ESOP is the ability to protect and preserve legacy and culture. Soon after, they discover the tax advantages and opportunities to maximize their return on a sale to an ESOP.
If preserving your company’s culture and legacy is important to you, an ESOP may be an option to explore. The company can remain independent, and the people who helped build it have the opportunity to benefit from its future success.
Employee ownership may also help create a strong internal culture and support efforts to attract and retain talent. But an ESOP can’t create a good culture on its own. It works best when a company already has employees who are engaged in the business and a management team capable of leading it after the owner steps away.
Understand how the financing works.
Many ESOP formations use senior debt to provide liquidity to the selling shareholders.
In a leveraged ESOP, a bank may lend money to the company, which in turn lends the funds to the ESOP trust. The trust uses that money to purchase shares from the company. Additional seller financing is typically also part of the transaction.
Over time, company cash flow supports repayment of that debt. As the ESOP loan is repaid, shares are released and allocated to eligible employees’ ESOP accounts.
That makes the strength of the business important. We typically look for steady and consistent cash flow, a strong balance sheet, growth potential and, perhaps most importantly, a great management team.
An ESOP should support a healthy business instead of being used to solve the problems of an unhealthy one.
Look beyond the initial sale.
The day the owner sells shares is only the beginning of an ESOP.
As employees retire or leave the company, they may become eligible to receive the value of their vested ESOP shares. That creates future cash needs that the company needs to understand and plan for. As debt comes down and cash flow changes, financing needs may change too.
There can also be significant tax advantages for qualifying ESOP transactions and certain ESOP-owned companies. Those benefits depend heavily on how a transaction is structured, so owners should work with experienced legal, tax, valuation and ESOP advisors to understand their situation.
Have the conversation before you need an answer.
An ESOP isn’t right for every business, and it shouldn’t be considered in a vacuum. The important thing is knowing that it’s one of your options.
The best time to think about succession is well before you are ready to sell. That gives you time to compare your choices, understand what each would mean for you and your employees and prepare the business for the transition you ultimately want.
As succession starts to enter your thinking, talk with your financial advisor about all options before you get too far down the road. You don’t need to know the answer yet. Starting the conversation is the important part.
Kevin Suchecki is Managing Director, ESOP Finance at Pinnacle Financial Partners, dba Synovus Bank. He is based at our Overton Park office in Atlanta and can be reached by email at Kevin.Suchecki@synovus.com and by phone at 404-364-2739.
