I was reading an article in the New York Times last week about how a company used an ESOP to help the founder exit from their business. As I was reading the article I thought there were some things that might be useful to review if you’re thinking about an ESOP, (and every business owner I’ve talked to has thought about one).
For those who don’t know, an ESOP stands for Employee Stock Ownership Plan. An ESOP is a qualified retirement plan and as such has tons of regulations that are governed both by the IRS and the Department of Labor. I’m not going into the technicalities of an ESOP, just some of the things you would want to think about if you’re contemplating doing one.
If you’re thinking about an ESOP here are some of the top things I think you should consider:
- Is the market valuation of your company higher or lower than a fair market valuation? If it’s higher you might be leaving a lot of money on the table. If it’s lower, then an ESOP might make sense.
- Is your management team competent? An ESOP is not the type of thing you do and walk away from. Having competent management who can take over the operation of your company after you leave is very important. In fact, without competent management I think an ESOP makes no sense.
- Are you willing to hold paper? If you’re not willing to be a creditor of the ESOP, then you might find it difficult to do a complete exit at one time. There are banks who loan to ESOP’s, but they usually are not willing to do a 100% leveraged buyout.
- Are you willing to stay involved in the company after your exit? Since you will likely be a creditor of the company, it’s important that you stay involved for at least the time it takes to have your note paid off.
- Are you willing to share company financial information? ESOP’s that tend to work the best are the ones that run with open book management. If you’re willing to share your company’s financials, then open book management is a viable option.
I’m a huge fan of ESOP’s in the right situation. A starting place might be to get our complimentary report on how ready is your company for an exit. Click on the button at the bottom of this post to go to our special report page.