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Five Reasons a Sale to an ESOP Could Be Better Than a Sale to Another Buyer

By Mary Beth H. Gray

An ESOP is Willing to be a Minority Shareholder

Very few buyers are willing to invest in a company and not own a controlling stake. Business owners who are considering an exit strategy are often forced to decide in a single transaction that they are ready to sell and that they are ready to give up control of their companies. An Employee Stock Ownership Plan is a company-sponsored benefit plan, the main purpose of which is to provide a retirement benefit to employees. For this reason, the ESOP (and its trustee) do not expect to control the operations of the company. An ESOP can own any percentage of a company from 1% to 100%. A business owner who is looking for some liquidity for shares can sell a portion of those shares to an ESOP and maintain both voting and governing control of the company.

An ESOP Sale Maintains Independence and Legacy

For many business owners, the value of their business is connected just as strongly to its culture as it is to its financial worth. Because a sale to an ESOP does not require any change in governance or management, owners looking to sell are able to use an ESOP sale to achieve some financial liquidity without sacrificing their legacy. To insiders and to the outside world, a company whose ownership has transitioned from a founder to an ESOP looks unchanged, other than by the often substantial motivating effect the ESOP can have on the employees. Certain metrics bear this out – for example, research shows that in companies with an ESOP, both overall sales and sales by employee are higher than in similar companies without ESOPs.

An ESOP Sale is More Tax-Efficient for the Seller

Sales to ESOPs offer unique tax-deferral opportunities not available in more traditional stock sales. In certain transactions, sales to ESOPs offer the seller the advantage of investing the sale proceeds from the stock sale in such a way that the gain on the sale is deferred indefinitely. With the right transaction structure, a seller can effectively increase the value of the sale by keeping more of the value of the stock after the sale.

An ESOP Sale is More Tax-Efficient for the Company

A sale to an ESOP offers tax advantages for both C corporations and S corporations. A C corporation with an ESOP can deduct both the principal and interest on a loan used to complete the ESOP sale. An S corporation with an ESOP pays no federal income taxes on the portion of the company’s income attributable to the ESOP (up to 100%!) These advantages are unique to ESOP companies and give ESOP companies the opportunity to save cash and reinvest that cash in strategic and capital planning.

An ESOP Provides a Long-Term Market for Stock

Almost all privately-held companies will be sold, usually more than once in a generation. But ESOP ownership is designed to be virtually perpetual and gives the employee owners and management an opportunity to focus their skill and energy on initiatives other than succession planning. But ESOP ownership is not a barrier to other transactions. ESOP companies can buy other companies and can be sold, and in these transactions can often produce additional liquidity events from the value built up by the tax advantages available only to ESOPs.

For more information on ESOPs contact Mary Beth Gray at mbgray@kleinbard.com or at 215.496.7255.