Exit Planning--Structured Financial Partners: Building value for your company's tomorrow ℠

ESOP as an Exit Planning Strategy

Our clients are owners of companies in a certain niche in the business landscape. They typically generate between $5 million and $100 million a year in revenue. We refer to this as "small middle market." When we talk to these business owners about "exit planning," we typically focus on a sale of their company to third parties in some form of an M & A transaction OR the transition of the company to insiders. Insiders are family members, existing co-owner(s) or a key employee of the entire management team.

These types of transactions are available for all businesses, large and small to consider.

There is a third type of transaction that that isn't appropriate for most business owners we talk to, BUT when it is appropriate, it can be an incredibly powerful tool. That is the sale of the company to an ESOP.

ESOP stands for Employee Stock Ownership Plan. It is a qualified retirement plan covered under ERISA. Unlike other ERISA retirement plans, which are forbidden from investing in employer securities, an ESOP must invest primnarily in the stock of the employer.

So, in essence, with an ESOP, the shareholder(s) create the entity that will purchase his or her stock. We'll get into the mechanics of that later.

Owners selling to an ESOP can achieve many of these objectives:

• Diversifcation of personal wealth without incurring tax liability or giving up control of the company.
• Transfering management to the next generation.
• Passing ownership to key management, who may not have the funds available to acquire the shares outright.
• Funds to buy out a co-shareholder.
• A method to raise capital at a reduced cost to expand the business.
• Create an employee ownership culture to increase profitability and aid in employee recruiting and retention.
• Create a 100% employee owned company that is also 100% exempt from federal (and most state) taxation. (S-Corp ESOP)
• Spin off a line of business without selling to an industry competitor.

While bank lending for ESOPs in these economic is tight just like other lending and ESOP promoters only talk about the benefits of ESOPs, let me take a moment and talk about some of the downsides.

• They are expensive to install and administer. Depending on the size of your company, the first year cost could be $75,000-100,000 or more. Annual administration requires that the company has a formal valuation EVERY YEAR. Expect annual administration (including the appraisal) will run approximately $30,000.
• The ESOP is a separate entity with its own board and cannot be run as a puppet for the benefit of an owner. All the formalities must be observed.

Next we'll explore ESOP in more detail

The risk of not planning

Here's another post from my partner, Susan Laine.

I heard a story today from an appraiser who specializes in valuations of closely-held businesses. His story was a cautionary tale to owners who do not plan for their ultimate transition out of their business whether the transition is on schedule or due to unforeseen events.

There was a family trucking business with annual revenues in excess of $50 million. The father and son #1 ran the business. Son #2 was a trucker and not involved in the management of the business. One client was responsible for more than 50% of their revenue and the account was well managed by the father and Son #1.

The father, a pilot, took a trip with the mother and son #1. The plane crashed and all three died.

Son #2 was not equipped to run the business. In a short time, revenues fell by 75% from where were before the family tragedy.

If the father and sons had done Exit Planning with us, we would have addressed a wide variety of issues—from the concentration of revenues with a single client to the death of any or all of the family members—the business would have been able to survive.

A little planning would have gone a long way in preparing the business for this unforeseen event.