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  • Financing Your Business Transition
    Game Plan
    In-Depth

    Option 2: Sell to Your Employees Through an ESOP

    AdvantagesAdvantages

    advantages

     
     
    • Continuity. Selling to your employees through an employee stock ownership plan (ESOP) could provide the most seamless and smooth transition. Your employees will continue to work with little change except they'll build on what they already own. ESOPs typically grow gradually, as ownership share rises slowly and steadily.
    • Simple and easy sale. If you sell to your employees, there’s little need for extensive financial due diligence. That also can ease stress over the transition to new owners and new management. The senior managers should already be familiar with the firm’s financial situation as well as its customers, products and competition.
    • Tax advantages. An ESOP is a tax-friendly way for a small business owner to receive value for the business. There are ways to defer tax liability from the sale for several years. The company generally benefits from making a tax-deductible contribution into the ESOP. And you, as small business owner, would owe capital gains tax on your profit. That tax rate is generally lower than the ordinary income tax rate, which is what you’d pay if you took profits directly from the company.
    • Employee commitment and productivity. ESOPs can be a powerful tool that can help to motivate employees to work harder and be more productive. As a result, companies with ESOPs can be very successful relative to others, as measured by revenue growth, job growth and wage growth.
    • Flexible terms. The terms of the transfer of the ESOP shares can be very flexible. You could sell your entire stake in the business now, do a partial sale, or gradually sell shares to the ESOP over many years.
    DisadvantagesDisadvantages

    disadvantages

     
    • ESOP set-up can be time-consuming. Setting up and maintaining an ESOP can be time-consuming and costly, particularly for relatively small firms that don’t have much money or interest in hiring ESOP consultants, valuation experts and lawyers.
    • Subject to regulation. Current government regulation and the threat of changes to or additional regulations in the future might be worth considering.
    • Can tie employee fortunes too closely to the company. While it can be positive to create a deeper bond between employees and the business, from an asset allocation standpoint, it could be risky because of increased concentration. Employees already have a financial connection to the company through their jobs. Adding partial ownership to that adds to the risks if the company falters in some way.
    Deciding FactorDeciding Factor

    deciding factor

    Do you believe your employees are capable of carrying on the business? Are they interested in doing so? This is an option that could work only if you have long-term employees who’ve helped you build your company, and want to continue it.

    Game PlanGame Plan

    Game Plan

    • If you haven’t set up an ESOP, do it keeping in mind the eventual sale of the firm to its employees.
    • If you have a well-established ESOP, and are close to bowing out of the business, meet with your accountant, attorney, ESOP consultant and a valuation expert to prepare for the transfer of ownership.
    • Learn more about ESOPs.