Seven Reasons Why Now is a Good Time to Consider an ESOP

By Mark Kaiser

Many family-owned and privately-held businesses have postponed thoughts of selling their business.  I have noticed an up-tick in companies considering a sale of all or part of their business to an Employee Stock Ownership Plans (ESOP) and wondered why.  After interviewing some experts, I discovered that there are several unique dynamics created by the pandemic.

1.  Company valuations are often higher in an ESOP sale than a sale to a strategic or financial buyer. ESOP valuations are determined by a discounted cash flow (DCF) analysis.  The historically low interest rates mean that DCF valuations can be much higher (we have seen cases of as much as twice as high) than an EBITDA or other market based valuation. 

This is especially true for companies that have consistent revenue and earnings. DCF calculations value consistent earnings over growth.  Private equity and strategic buyers often focus on high-growth as a key driver of valuation. The variables and assumptions in DCF calculations need to be realistic, defensible but are not like the more confrontational adjustments to EBITDA we see in M&A transactions or private company sales.

2.  Companies of all sizes can implement an ESOP sale.  It’s generally a good idea that a company have a minimum of $1 million in EBITDA before considering an ESOP.  However, one benefit of low interest rates is that smaller companies can often better afford the cost of financing the transaction and the risk of over leverage can be much less than when interest rates are high (and many leveraged buyout companies got into trouble).

3.  Favorable tax treatments may not last much longer.  Currently ESOP transactions typically have attractive tax advantages including deferral and/or exemption from certain taxes. As lawmakers consider how to pay for the massive economic stimulus packages and huge federal and state revenue shortfalls, discussions focus on raising tax rates, boosting estate, gift and generation-skipping transfer tax rates likely will be on the list of things that might get changed.  The tax picture could also change depending on the November election results.

4.  An ESOP provides for a better future for your employees.  An ESOP provides a long-term approach to caring for your employees. An ESOP is designed to provide additional benefits for employees at retirement.  The ESOP benefits are in addition to your existing 401(k) or other retirement plans.  This builds further employee loyalty and creates a great legacy for the founder/owner that the company will continue in business for the benefit of all employees.

5.  An ESOP sale offers greater confidentiality and certainty of close.  Sales of companies to private equity or strategic buyers often get restructured from the Letter of Intent to final deal based on due diligence findings and typically require legal representations from the selling shareholder(s). The ESOP process relies on the Discounted Cash Flow analysis to set the sales price and, once set, the sales price/valuation is firm and not subject to the same due diligence adjustments in other sales.

6.  Establishing an ESOP creates few changes from a governance or reporting perspective. As before the ESOP, shareholders select the management and management runs the company. While the ESOP is a beneficial owner of some or all the shares, ESOP members (employees) do not sit on the company’s board or manage operations. An external ESOP Trustee represents the employees interests.

7.  ESOP owned companies outperform conventional companies during challenging times.  This is likely the most important reason to conslider an ESOP for your company at this time. Research from Rutgers University’s Study of Employee Ownership and Profit Sharing found that in the wake of the 2008 financial crisis, ESOP companies grew sales by average of 11.1% while non-employee-owned companies grew by just 0.61% (less than 1%).

Because employees are co-owners, they are more likely to find ways to boost sales and cut costs to drive profitability in both good times and bad. Your employees will work harder as owners and that benefits everyone associated with the company.

In the final analysis, an ESOP sale of your company in the near term can be a unique situation that is a win for all parties.  You as the owner can receive fair market value, tax advantages in the sale, the ability to continue to manage the business (if you’d like) and employees get true participation in the financial success of their company.