Often, owners of successful closely-held companies are concerned for what will happen to their dedicated employees— and the business itself—long before they ever consider selling or departing from the business. These closely-held companies often use Employee Stock Ownership Plans, or ESOPs, to offer employees a vested interest and long-term stability in the company through employee ownership. This not only offers an additional benefit to employees, but also affords them the opportunity to take advantage of the tax-efficient borrowing power of ESOPs.
WHAT IS AN ESOP?
Similar to profit-sharing, ESOPs act as an established employee benefit designed to offer employees the opportunity of ownership (or shares) in a company, while also giving them a partial voice. Consequently, as employees become more engaged with an organization, a well-structured ESOP often helps to improve an organization’s performance, while simultaneously helping to increase the value of its shares.
HOW ARE ESOPS USED?
In my experience, clients have used ESOPs to create liquidity for owners that may not normally exist in their respective industries; to borrow tax efficiently to reduce the financing costs of the transaction and to not overburden the company; and to help employees become owners with the goal of improving efficiencies, while having a vested interest in the long-term performance of the company.
For example, a contractor client set up an ESOP to create liquidity for the owner that didn’t exist prior to setting it up. The value received through the ESOP was higher than what the owner could have obtained by selling the company to a competitor. Unlike my knowledgeable client, many other business owners in this industry would’ve sold solely for the value of the accounts receivable, and not a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization). This owner also used the ESOP to form a tax-efficient vehicle for the owner’s son, who continued to run the company. The new company did not pay tax on the percentage of the earnings owned by the ESOP.
He also later noted to me that his employees became noticeably more engaged in the financial success of the company after becoming owners. Through ongoing education and communication, the employees learned the benefits of owning a company that was more cost conscious and efficient.
After the loans from the initial transaction were paid off, we completed the remainder of the sale of the shares to create a 100% ESOP-owned company. Thereafter, the son was able to acquire other companies with a more tax efficient company, and offer sellers an opportunity to gain liquidity in a tax efficient manner. Similar to the original transaction, the fully-owned ESOP company was able to offer a higher price vs. a regular company because of the allowable ESOP tax advantages.
Joe Pacis is a Commercial Loan Officer with First Bank. If you’d like more information on the benefits of an ESOP or how to get one established, contact the First Bank team by calling (562) 951-5101, or e-mail Joe via Joe. Pacis@fbol.com.