If you own a business and have not put a succession plan in place, you might be thinking that the best choice, when the time comes to retire, is to simply sell your business outright to the highest bidder. However, selling your business to your employees may be a better option in certain situations, through what is known as an Employee Stock Ownership Plan (ESOP).
Here’s how an ESOP works. The company in question creates a trust on behalf of its employees. A portion of the profits are directed into the trust, which in turn uses the money to purchase the owners’ shares. This purchase can take place over time or all at once. Employees can minimize the potential burden of the purchase by borrowing against future earnings, without incurring costs upfront.
How prevalent is the use of ESOPs in business transitions? There are currently more than 10,000 companies successfully using ESOPs. These companies include well-known, large firms, as well as smaller companies.
The decision to use this succession strategy depends on a variety of factors. For example, if you are interested in leaving a lasting legacy or rewarding the people who have worked for you over many years, an ESOP could be an excellent way to do so. There can also be tax benefits. If you sell more than 30 percent of the company to your employees, capital gains taxes are deferred, as long as the proceeds are invested in American companies. Furthermore, in companies where employees have a stake in ownership, studies have shown that productivity and profits improve.
Of course, there are risks to this strategy. For example, the long-term value of the firm, and its ultimate selling price, can fluctuate as a result of changes in the business, the economy and more. Nevertheless, for business owners looking to leave a legacy, reward employee loyalty, and reap tax benefits in the process, selling to employees could very well be an excellent option—a satisfying reward for taking the risks and putting in the hours necessary to build a successful business.