6 Reasons to Consider an ESOP for Your Business

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Key takeaways:

• ESOP benefits offer flexibility, allowing business owners to sell all or part of their business while maintaining control.
• Transitioning to an ESOP helps preserve your legacy and keep jobs and culture intact.
• Employee ownership improves retention, recruitment and engagement, giving your business a competitive edge
• Selling to an ESOP protects confidentiality and strengthens resilience during economic downturns.

What is an ESOP and why consider it?

An Employee Stock Ownership Plan (ESOP) is a benefit plan that gives employees ownership interest in the company, usually through shares held in a trust. A business owner can benefit financially from selling his or her business to employees using an employee stock ownership plan (ESOP) structure. Using an ESOP for ownership transition can achieve significant non-financial benefits as well.

There are many advantages of employee stock ownership plans. Discover six reasons this structure may be the right solution for you, your business, and your succession planning.

1. If You Prefer to Sell Part of Your Business

One advantage of an ESOP is the flexibility an ESOP structure provides. Unlike a sale to a private equity firm or a strategic buyer, a sale to an ESOP doesn’t have to be an “all or nothing” proposition. An ESOP can be used for a partial exit—an option that may be very useful in a variety of situations including:

• Providing minority shareholders a vehicle through which they can sell their shares.
• Divorcing couples who are joint business owners.
• The need to create liquidity to compensate owners who are ready to leave the business, while not undermining the foundations of the company or forcing a sale by those who wish to remain involved.
• Allowing owners to partially monetize their ownership for diversification purposes.

2. Protect Your Legacy

Some people close the door on a business and that’s the end of it for them. Get the best price possible, and ride off into the sunset, looking forward to enjoying all the things they didn’t have time for while building their business.

For those who see that transition differently, an ESOP can be a more attractive solution. An ESOP enables your employees to become part of your legacy. It allows you to keep your name on the door and continue to participate in—and guide—the running of your company. For example, if you are a major employer in your community, provide economic vitality, jobs and opportunity to the area, there is no “outsider” who could decide to move the operation to another city. Or if you were an innovator in improving the employment conditions in your office or plant, an ESOP may afford you the opportunity to maintain and possibly expand those innovations.

If you’re looking to create more space in your life for non-work activities, but still want to make the most of your energy and expertise with regard to your business, an ESOP can be structured to allow you to do just that.

3. Recruit and Retain the Best Workers

Recruiting and retaining people is one of the biggest hidden costs for any company, especially in very competitive markets. Being able to offer potential employees a piece of the business can be a powerful recruiting tool, compensating for an inconvenient commute or location, or differences in medical benefits. Plus, ESOPs are simpler to set up than other options, such as worker cooperatives, but can provide similar benefits in terms of providing financial empowerment for employees.

Evidence from a recent survey by the National Center for Employee Ownership (NCEO) suggests that companies offering ESOPs experience significantly higher employee retention. Findings demonstrate that these companies have voluntary-quit rates that are approximately one-third the national average.

ESOPs also have positive effects on retirement savings plans as well—particularly for women and people of color. Statistically speaking, these groups make smaller contributions to retirement plans such as 401(k)s due to lower wages than their white, male counterparts. ESOPs, unlike 401(k)s, are not tied to earnings, which can make it easier for a broader swath of employees to accumulate shares.

An ESOP can even be structured to include contract workers, giving the business a real leg up in competing for talent. Having a real stake in the business is a benefit that isn’t available in all companies and certainly is seldom available to non-full-time employees. Likewise, transitioning to an ESOP can help you retain valuable employees, providing a financial benefit to the owner beyond the increased liquidity and tax advantages. In fact, studies show that employees who have “skin in the game” feel greater loyalty to their company and exhibit a higher level of productivity.

4. If You Want to Maintain a Sense of Control

Another way an ESOP can prove to be a more flexible alternative to a third-party sale is that it allows the owner to continue managing and guiding the company.

The liquidity provided by the sale to employees allows you to diversify your holdings while continuing to participate in the leadership of the business. You can remain actively involved in your company’s future—within the bounds of good corporate governance and Employee Retirement Income Security Act (ERISA) fiduciary rules.

5. Protect business information from competitors

One of the top concerns of business owners when selling their business is confidentiality. The fear that confidential information gets leaked, or even that there is a sale process for the business, is a legitimate concern. Having financial information, customer lists, proprietary processes, or strategy plans leaked can cause substantial harm to a business. And while confidentiality agreements try to put a fence around this issue, once the horse has left the barn, the damage is done.

By selling to an ESOP, the risk that sensitive information gets out is substantially reduced. No concerns about sharing financial information; no worries about having your best customers pilfered; no issues with your vendors getting nervous about who they’ll be dealing with if the company sells. Selling to an ESOP reduces the anxiety with all of these issues.

6. Weather potential economic downturns

ESOP-owned companies have shown surprising resilience even when the economy as a whole is facing problems. A 2010 study conducted by Phil Swagel and Robert Carroll of the McDonough School of Business at Georgetown University tracked the performance of ESOP-owned companies and showed that even during the first year of the 2008 recession, they were adding employees and seeing double-digit growth.

Additionally, a recent study by Rutgers School of Management and Labor Relations demonstrates that most employee-owned companies offering ESOPs outperformed non-employee-owned companies in employee retention, workplace health and safety, pay and benefits. In fact, during this time, findings show that organizations with ESOPs were three to four times more likely to retain staff.

Both studies highlight the resilience and strength of employee ownership models in times of economic uncertainty, emphasizing that when employees are invested in the success of the business, the organization is better equipped to adapt, endure and emerge stronger.

In conclusion

For business owners who are interested in moving on but have felt stymied by any of the above considerations, an ESOP provides a flexible alternative to a sale to a financial or strategic buyer.

As with any endeavor of this kind, such a transition requires a great deal of preparation and a team of professionals with expertise in the creation of ESOPs. It’s really a trifecta—ESOP tax advantages, financial liquidity and securing of your vision for your company.

With decades of experience and an unwavering commitment to client success, Fifth Third is prepared to guide your organization through the complexities of ESOP Planning with tailored solutions and experienced advisors. To learn more, connect with an experienced ESOP professional.