Business owners often have a sense of gratitude towards their employees – they understand that they couldn’t have built their business without those employees and want to see them have the opportunity to run the business and enjoy the fruits of ownership. Over 50% of my clients express an initial desire to sell to employees if the key employee group (KEG) can obtain financing for the purchase.
There are generally two avenues that can be taken here – a sale of the company directly to the KEG or a sale to an Employee Stock Ownership Plan (ESOP). An ESOP is an IRS/Department of Labor qualified retirement plan with a unique feature – it is the only retirement plan that is allowed to own shares of the sponsoring company’s stock. The net effect is that each employee winds up owning stock in their retirement plan account. Ownership is distributed via annual contributions that the company makes to the ESOP/retirement plan, with those contributions allocated based on compensation. In an earlier article (ESOP versus M&A, May 2016) we considered a sale to an ESOP versus a sale to a third-party. Here we will consider the sale to an ESOP versus a sale to a key employee group.
An ESOP involves significant regulatory oversight from both the IRS and the Department of Labor; in order to consider an ESOP the firm must be large enough and the benefits great enough to absorb fixed administrative/regulatory costs. We think a company must have a minimum of $1 million in EBITDA (cash flow) and $1 million in payroll before an ESOP can be considered a viable option.
Tax benefits, financing, management, culture, and of course, cost are just a few of the areas to be considered when evaluating whether ESOP or sale to a KEG is the most advantageous option when the owner intends to sell to key employees.
Business owners are frequently motivated to reward their employees as part of an exit transaction, if the owner’s personal financial objectives can be met. Every situation is different and the pros and cons of an ESOP versus a management buy-out must be considered case by case.
This blog is an excerpt from my article featured in the December 2016 issue of Business2Business magazine.