In the News

Forbes

Mary Josephs - Contributor 

Dealing with challenges created by COVID-19 and facing a likely recession, many family-owned and private businesses have postponed thoughts of selling their businesses. But as owners become more adept at managing through the “new normal” – and especially as they eye potential tax changes next year — more of them will again consider their future business options, one of which should be establishing an employee stock ownership plan.

ESOPs are widespread, with more than 7,000 in the U.S. Operationally, a company sets up a retirement plan trust, similar to a 401(k) plan), for its employees and annually contributes or allocates company stock directly to the plan. Sellers can permanently defer capital gains, which may increase in the future, and their companies could be exempt from federal income taxes that also may increase ahead. 

In view of their many benefits, here are six reasons why business owners should consider an ESOP now:

No. 1: ESOPs outperform conventional companies during challenging periods. Research from Rutgers University’s Institute for the Study of Employee Ownership and Profit Sharing and others finds that during the steep 2008-09 financial crisis, ESOP companies grew sales 11.1% while non-employee-owned companies grew by just 0.61%. And net employment at ESOPs climbed over 60% during 2001-2011 vs. no change elsewhere, concludes research by Alex Brill, CEO of consulting firm Matrix Global Advisors. 

No. 2: Because employees are co-owners, they’re more likely to find ways to boost sales and trim costs in a downturn. ESOP employees’ retirement accounts depend on working together; and teamwork, nimbleness and responsiveness describe the typical ESOP’s culture. Billionaire Shark Tank investor Mark Cuban favors giving employees equity. “Your employees will work harder” as owners “and that benefits everybody,” he maintains.   

ESOP companies better provide for their workers’ employment and retirement security. Employee-owners were four times less likely to be laid off during the 2008 recession. The ESOP Association recently calculated that an employee at an ESOP company is 6.2 times less likely to be laid off than at a non-ESOP company.

Plus, since they’re privately held, ESOPs can take a long-term approach to operations without having to report short-term earnings as public companies must. In the post-COVID-19 world, ESOPs can be patient as we look past the multi-year timeline to restore GDP to pre-virus levels.

No. 3: In contrast to a sale to a strategic or financial buyer, selling to an ESOP offers greater confidentiality and certainty of close. Sale negotiations to private equity buyers can raise the ante on due diligence and require assurances from the selling shareholder, which can prove disruptive to the company. Quite often, and more so with today’s COVID-19 capital constraints, price terms and conditions can slip from LOI to final deal. It makes sense for a seller’s financial advisor to run a dual-track process, conducting a traditional auction while simultaneously pursuing a sale to an ESOP.

No. 4: An ESOP helps with inter-generational wealth planning. A partial ESOP can enable a family to diversify its stake in the business while still retaining control and providing an outlet for later generations’ entrepreneurial passions. In conjunction with solid wealth planning, owners can achieve and enhance their philanthropic and wealth planning goals.   

Look for an advisor who puts an ESOP’s benefits in simple terms without getting enmeshed at the outset in the intricacies of the ERISA tax code. If an ESOP structure works holistically, then pivot to the very important analysis of creating a plan that provides attractive retirement benefits to employees and doesn’t raise flags with the Labor Department.

No. 5: Establishing an ESOP creates few changes from a governance or reporting perspective. As before, shareholders select the management, and management who runs the company. While the ESOP is a beneficial owner of some or all of the shares as well as a retirement plan trust for participant employees, ESOP members don’t sit on the board or manage operations. As a trust, they certainly will benefit from strategies to grow the value of their share; their participation will not be intrusive.

No. 6: The rationale for considering an ESOP may well prove more urgent ahead as lawmakers consider how to pay for the massive economic-stimulus spending and huge funding shortfall during the pandemic. Already, several tax proposals are being floated that, among others, could abolish the lower tax rate on federal capital gains in favor of raising ordinary income tax rates, raise the Social Security wage ceiling, and boost federal and state estate, gift and generation-skipping transfer tax rates. The tax picture in 2021 and beyond also could change depending on the outcome of the November election.

In the final analysis, ESOPs can be a win for all parties. Business owners receive fair market value, a tax deferral opportunity, and the ability to continue to have an equity interest in their business. For management, there is the opportunity for continuity and ownership stability, increased employee productivity, and attractive corporate tax advantages. For the employees, there is the opportunity for additional retirement security alongside the motivation of true participation in the financial success of their company.

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