Every business owner I’ve talked with is interested in ESOP’s. On the surface an ESOP (Employee Stock Ownership Program) looks like a way to sell your business, pay no taxes, and stay in control of your business until you no longer want to be in control. Like anything that looks too good to be true often an ESOP sale just doesn’t work out the way they initially look.
There tends to be two reasons people do ESOP transactions. Owners who sell their companies to an ESOP often can’t find a reasonable buyer or they want to perpetuate a culture they’ve developed. I find that when both are part of the ESOP transaction owners often enjoy the best of both worlds.
I know of one owner in Burlington, VT that choose the ESOP route for his company because he wanted to make sure the 200 plus jobs the company had would stay in Vermont. He decided to forgo several million dollars he could have received from an outside buyer. If he took the money the jobs would have left the State. For him the jobs staying in Vermont was more important than the extra money.
Another company I know couldn’t find a buyer for their company. They had one customer and the valuation they got for a fair market value of their company was significantly larger than if they were to find a third party buyer. This company was sold to the ESOP for economic reasons first and company culture reasons second. In this particular case the ESOP was economically successful but not as successful from a cultural point of view.
ESOP’s work better for cultural reasons. When an owner sells their company for economic reasons first the ESOP will often have a short lifespan. ESOP’s are complicated beasts and unless management is totally committed to running their company as an ESOP the hassle becomes too great to stay independent.
Eventually the next level of managers in an economically motivated ESOP will want out. They haven’t been prepared and often don’t even believe in including employees in information and running the company. In addition, the extra level of administrative details is more than many managers are willing to accept.
Starting an ESOP small is a good idea. I like to see ESOP’s started as a partial ESOP before an owner totally jumps into a wholly owned ESOP structure. This gives the owner and his or her management team a chance to see how a 100% ESOP companuy might look like.
The team has a chance to see what problems have propped up with having an ESOP. The owner and his team can then either choose to correct the problems that have occurred or they can decide to not transfer their business through the ESOP. The owner would then look for another avenue to transfer their business.
Financial incentives for ESOP’s need to be secondary to cultural issues. ESOP’s work great when a participatory culture has been established in the company before the ESOP is formed. When employees are used to being part of the value proposition of a company, ESOP’s makes a lot of sense. I believe this is the determining factor in whether an ESOP will go past five to seven years (the average lifespan of an ESOP).
It takes time to build a culture where all employees are used to identifying and solving problems. Spending this time before forming the ESOP will pay huge dividends. If after you’ve built a participatory culture and doing an ESOP is not for you the company might just be more valuable.
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