Capital Insights: ESOPs and Succession Planning: What Types of Businesses Should Consider an ESOP?
May 10, 2018 - By: SC&H Capital
In the world of succession planning options, an Employee Stock Ownership Plan (ESOP) is an alternative to a third party sale that warrants consideration from privately held business owners. An ESOP provides a tool for a business owner to create an internal, tax advantaged buyer for privately held stock without the need for the disruption of the existing corporate culture that often accompanies third party transactions.
While family-owned businesses are responsible for an estimated 60 percent of total U.S. employment, roughly 70 percent of these businesses last a single generation. This reality places a premium on succession planning, especially among business owners who want to see their family business continue for multiple generations. ESOPs provide family-owned businesses the opportunity to create liquidity for selling shareholders, while avoiding the sale of the company to a 3rd party.
There are no restrictions on what types of companies can implement an ESOP, however, there are some common industries in which ESOPs have become a popular succession planning solution. ESOPs are especially prevalent in several industries for a variety of reasons, which can include the relative scarcity of third party buyers, importance of maintaining corporate culture, and the strength of balance sheet to facilitate liquidity in a leveraged ESOP transaction. Some of these industries include:
Construction – In an industry densely populated by mid-sized firms—the Small Business Administration reports that there are more than two million construction firms in the U.S. with 500 or more employees—there are relatively few third party buyers. Also, many construction companies are family-owned.
Government Contracting – The federal government has mandated set-asides to “ensure small businesses get their fair share of work in the federal market.” One of the outcomes of the law, however, is that large government contractors rarely acquire small government contractors that rely on set-aside contracts because they are often precluded from renewing those contracts—dramatically reducing the pool third party buyers for certain lower middle market contractors. Also, ESOP contributions are allowable costs that may be passed through within the indirect rate structure of plan sponsors and, therefore, reimbursed by the government.
Manufacturing and Distribution – According to a recent report published by American Express, manufacturing, along with wholesale trade, represent nearly one-third of all middle market firms in the U.S. In addition, many boast consistent profitability and strong balance sheets with fixed assets—all of which create the ability to leverage the balance sheet to create liquidity for selling shareholders in an ESOP transaction.
Professional Services – Architectural and engineering firms, in particular, are motivated to maintain their organizational culture because their personnel—by virtue of what and whom they know—are among their foremost assets. As companies with high payrolls, professional services firms are often able to make substantial tax deductible ESOP contributions. In addition, many professional service firms are already largely employee-owned by the senior members of the firm. Often times an ESOP transaction can re-allocate this employee ownership in a broader and more tax efficient fashion.
Ensuring a Successful ESOP
ESOPs have proven themselves to be a successful company ownership structure for a wide variety of businesses. No matter the industry, if a company is considering the path of converting to an ESOP, leaning on qualified advisors in the process is critical.
To learn more about ESOP’s and the benefits associated with this type of transition of ownership download our eBook “Employee Stock Ownership Plans: The Basics and Benefits.”