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Employee Stock Ownership Plans

Business owners are always thinking about the future of their companies, but how often does that thinking include succession planning?  More than half of small to mid-size private companies do not have a succession or exit strategy in place. Many believe that succession is merely turning over the Company to a family member or eventually finding a third-party buyer, but increasingly there is another popular option that is frequently overlooked or misunderstood – selling the Company to its employees.

 

Selling to an Employee Stock Ownership Plan

 

Employee Stock Ownership Plans (ESOPs) can be an ideal and flexible exit strategy option for business owners. Depending on how the plan is structured, an ESOP can provide a variety of benefits that accrue to all stakeholders:

 

  • The owner can sell from 0% to 100% and receive a full and fair market value for the Company

  • The owner can elect to sell tax-deferred/tax free

  • The Company can operate tax-free going forward

  • The history, culture and legacy of the family and Company are preserved

  • Employees are given ownership in the Company over time – without investing a dime

  • Existing Sellers/Management can continue to run and control the operations of the Company

  • Key employees can realize significant economic benefits via Stock Appreciation Rights (SARs) and their participation in the ESOP itself

 

What is an ESOP?

 

An ESOP is a qualified retirement plan for the benefit of the Company's employees. Rather than holding mutual funds, as is common in a 401(k) Plan, an ESOP primarily invests in the employer's stock. The ESOP rules are set forth in the Internal Revenue Code, and they provide two significant tax benefits:

 

  • The owner may sell his/her shares to an ESOP and either defer or eliminate the capital gain tax on the sale, thereby increasing the seller's net proceeds by approximately one-third when compared to any other type of sale. For instance, if an owner could sell the Company for $20 million to a competitor, he or she would net approximately $15 million after capital gains taxes. With a sale to an ESOP, the owner could net the full $20 million, or a $5 million increase.

 

  • Since an ESOP is a retirement plan, all of the Company's post-ESOP earnings may be federal and state income tax-free, significantly increasing the Company's cash flow. For instance, a Company with $3 million in taxable income would pay about 33% in federal and state income tax, or $1 million. With an ESOP, the income tax can be $0, for a savings of $1 million per year.

 

There are also personal benefits when selling a company to its employees. ESOPs are an especially attractive option for business owners who want their business to remain intact beyond succession while also rewarding loyal employees. For example, Kovatch Castings, Inc. (“KCI”), is an Investment Castings business in the Akron/Canton, Ohio area.  In late 2019, Doug Kovatch, the 100% owner and the son of the founder, announced that he was transitioning the Company to Employee Ownership. KCI had grown from $4mm of revenues and 40 employees in 1991 to over 200 employees and $25mm of revenues as a leading participant in the Investment Castings industry.  Doug's employees had been instrumental in helping grow the Company over the years while also cultivating a culture of safety, quality and support for the community.  As Doug noted, "I had looked into the possibility of third-party sale, but one of my board of advisers suggested I consider an (Employee Stock Ownership Plan). The more I learned about it, the more an ESOP became sort of the clearest strategy to meet my goals."

 

For KCI and Doug, the ESOP not only fulfilled personal financial goals, but it secured existing employees' roles while providing them with an opportunity to participate in the future success of the business. "It allowed me to keep in place my managers, who share my vision for our future, keep the Kovatch name and hopefully have it continue for many more generations to come."

 

 

Structuring an ESOP

 

Any time you sell your business, there is no guarantee of the outcome. You can, however, follow some guidelines to set up yourself and your company for success by developing and establishing a solid structure.  An ESOP can be incredibly flexible and structured to best meet the needs of the selling shareholders as well as current and future employees.

 

The complexity of a sale to an ESOP can vary by factors such as the number of owners or entities involved in the Company, the availability of reliable financial information, and the ultimate goals of the selling shareholders. 

 

Is an ESOP a good choice for me? 

 

It is essential to assemble the right team of advisors from the beginning who will help you choose the best path to achieve your personal and financial goals. Selling to an ESOP involves a number of professionals who have different expertise to address issues that may arise during the process. Pre-planning and having a qualified team in place to help guide you in choosing the right exit strategy for both you and your business can save significant time, money, and headaches down the road. 

 

Bandit Industries, Inc., a leading designer and manufacturer of wood and waste processing equipment, chose the ESOP path after abandoning two previous attempts to sell the Company – once to another manufacturer and once to a private equity firm. “We realized neither was a good fit for Bandit, so we made the decision to sell to our trusted employees,” said owner Dianne Morey.

 

For Bandit, the ESOP ensured the corporate culture that had made Bandit a success for 35 years would remain intact.  Owner, Jerry Morey, explains, "We have a very strong, dedicated dealer organization and a great crew, which is the key to our success. Our employees are experienced, smart and loyal to us, which is why we were so confident that an employee owned company would be the right fit for Bandit. All of our employees will have a stake in the Company."

 

Succession and exit plans are highly customized solutions. There isn't a template you can use for every business. However, experienced investment banking advisors will help you reach your goals by structuring and implementing the best succession planning strategy for your Company.  An ESOP transaction may be the right solution for business owners who desire to create a smooth transition, retain a life of relevance, preserve their legacies and reward their employees.  

Is an Employee Stock Ownership Plan Right for You?

Business owners are always thinking about the future of their business, but how often does that thinking include succession planning? The facts are that more than half of small to mid-size private companies do not have a succession or exit strategy in place. Many believe that succession is merely turning over the company to a family member or eventually finding a third-party buyer, but increasingly there is another popular option that's frequently overlooked or little-understood – selling the company to its employees.

 

Selling to an Employee Stock Ownership Plan

 

Employee Stock Ownership Plans (ESOPs) can be an ideal and flexible exit strategy option for business owners. Depending on how the plan is structured, an ESOP can provide a variety of benefits that enables business owners to:

 

  • Defer and eventually eliminate capital gains taxes on the sale

  • Reduce or eliminate taxes at the company level post-closing

  • Create a retirement benefit for employees

  • Maintain business continuity

  • Maintain operational control post-sale

 

What is an ESOP?

 

An ESOP is a qualified retirement plan for the benefit of the company's employees. Rather than holding mutual funds, as is common in a 401(k) Plan, an ESOP primarily invests in the employer's stock. The ESOP rules are set forth in the Internal Revenue Code, and they provide two significant tax benefits:

 

  • The owner may sell his/her shares to an ESOP and either defer or eliminate the capital gain tax on the sale, thereby increasing the seller's net proceeds by approximately one-third when compared to any other type of sale. For instance, if an owner could sell the company for $20 million to a competitor, he or she would net approximately $15 million after capital gains taxes. With a sale to an ESOP, the owner could net $20 million, or a $5 million increase.

 

  • Since an ESOP is a retirement plan, all of the company's post-ESOP earnings may be federal and state income tax-free, significantly increasing the company's cash flow. For instance, a company with $3 million in taxable income would pay about 33% in federal and state income tax, or $1 million. With an ESOP, the income tax can be $0, for a savings of $1 million per year.

 

There are also personal benefits when selling a company to its employees. ESOPs are an especially attractive option for business owners who want their business to remain intact beyond succession while also rewarding loyal employees.

 

Take, for example, Arborwell Inc. in Hayward, CA. In 2017, Peter Sortwell, the founder, announced he was transitioning his company to Employee Ownership. Arborwell had grown from a small residential operation into one of the most recognized commercial tree care providers on the West Coast. Peter's employees had been instrumental in helping drive the company over the years while also cultivating a culture of safety and professionalism. To Peter, the ESOP was "a natural step, consistent with their (Arborwell's) recognition of the contributions of each employee in the success of the company, and his desire to share the rewards of that success." For Arborwell and Peter, the ESOP not only fulfilled personal financial goals, but it secured existing employees' roles while providing them with an opportunity to participate in the future success of the business. 

 

Structuring an ESOP

 

Any time you sell your business, there's no guarantee of the outcome. You can, however, follow some guidelines to set yourself and company up for success by developing and following a solid structure. An ESOP can be structured to best meet the needs of the selling shareholders as well as current and future employees.

 

The complexity of a sale to an ESOP can vary by factors such as the number of owners or entities involved in the company, the availability of reliable financial information, and the ultimate goals of the selling shareholders. 

 

Is an ESOP a good choice for me? 

 

It is essential to assemble the right team of advisors from the beginning who will help you choose the best path to achieve your personal and financial goals. Selling to an ESOP involves several professionals who have different expertise to address issues that may arise during the process. Pre-planning and having a qualified team in place to help guide you in choosing the right exit strategy for both you and your business can save significant time, money, and headaches down the road. 

 

Bandit Industries, Inc., a leading designer and manufacturer of wood and waste processing equipment, chose the ESOP path after abandoning two previous attempts to sell the company – once to another manufacturer and once to a private equity firm. “We realized neither was a good fit for Bandit, so we made the decision to sell to our trusted employees,” said owner Dianne Morey.

 

For Bandit, the ESOP ensured the corporate culture that had made Bandit a success for 35 years would remain intact.  Owner, Jerry Morey, explains, "We have a very strong, dedicated dealer organization and a great crew, which is the key to our success. Our employees are experienced, smart and loyal to us, which is why we were so confident that an employee owned company would be the right fit for Bandit. All of our employees will have a stake in the company."

 

Succession and exit plans are highly customized solutions. There isn't a template you can use for every business. However, experienced investment banking advisors will help you reach your goals by structuring and implementing the best succession planning strategy for your company.  An ESOP transaction may be the right solution for business owners who desire to create a smooth transition, retain a life of relevance, preserve their legacies and reward their employees.  

ESOP Transactions as a Succession Planning Solution

There are approximately 77 million Baby Boomers in the United States. According to AARP, 10,000 Baby Boomers are turning 65 each day and this trend is expected to continue into the 2030’s. A recent survey found that approximately 75 percent of privately held businesses owned by Baby Boomers will be sold during the next 10 years.

Many owners are terrified by the thought of selling their businesses and are unable or unwilling to confront the reality of their age and need for liquidity. The owner’s identity is commonly intertwined with the company that they founded and led for decades. Owners fear the sale of their companies will leave them dispossessed of their leadership of the company and take away their “place in the world.”

Business owners are also concerned that a third-party purchaser may shut down operations or move them overseas and terminate employees. Consequently, many successful business owners put off performing any type of succession planning until it is too late, and death, disability or financial distress results in a sale of the company for less than fair value.

A sale to an Employee Stock Ownership Plan solves these problems. An ESOP is a qualified retirement plan for the benefit of the company’s employees. Rather than holding mutual funds, as is common in a 401(k) Plan, an ESOP primarily invests in the employer’s stock. The ESOP rules are set forth in the Internal Revenue Code and they provide two significant tax benefits:

  • The owner may sell their shares to an ESOP and either defer or eliminate entirely the capital gain tax on the sale. This typically increases the seller’s net proceeds by approximately one-third as compared to any other buyer. For instance, if an owner could sell the company for $20 million to a competitor, they would net $15 million after capital gains taxes. With an ESOP, the owner could net $20 million.

  • Since an ESOP is a retirement plan, all of the company’s post-ESOP earnings may be federal and state income tax free. This typically increases the company’s cash flow by approximately 50 percent. For instance, a company with $3 million in taxable income would pay approximately 33 percent in federal and state income tax ($1 million). With an ESOP, the income tax may be $0, for a savings of $1 million per year.

While the economic benefit of an ESOP transaction is obvious, many owners opt for a sale to an ESOP since it speaks to the two issues discussed above: a fear of losing their identity when they sell and a concern for their employees’ well-being under new ownership. A sale to an ESOP also enables the owner to continue to lead the company post-closing with operational control.

There are more than 7,000 ESOPs in the United States and approximately 8 percent of corporate equity is owned by ESOPs. The sale of a company to an ESOP works with numerous types of businesses such as:

  • Consultancies, which sell time and advice

  • Companies in which the material portion of the purchase price is contingent, usually based on future earnings

  • C Corporations that sell assets

  • Any business without a natural buyer

  • Companies in which the intellectual capital of the employees is the true asset

  • ESOP transactions are also ideal for manufacturers, distributors, companies in the construction industry, IT consultancies and staffing firms.

 

As the Baby Boomer generation continues to age and seek a means to obtain liquidity from their companies, an ESOP is an ownership transition tool that may provide them the greatest after tax proceeds while preserving their “place in the world” and their employees’ jobs.

December 12, 2019

Bruce Lazear Lays Out The Anatomy Of An ESOP

Often, growing your company is not just about making money. It’s a part of your identity.

“The idea of selling to a third party and being told it’s time to play golf for the rest of your life is terrifying to many,” Bruce Lazear says. “They don’t want to be irrelevant — and being rich doesn’t make them relevant. They have friends at the country club bored to tears.”

The partner at Lazear Capital Partners can identify with that.

“As someone who has had a business for 20 years, I appreciate how much it means to me at a level that’s beyond its earnings,” he says. “It’s part of my life. I enjoy the creative process of going to work. So do our clients.”

“With an ESOP, they can remain the CEO, even as they get their liquidity and their payments, and still be part of leading their team, growing their people and servicing their customers,” Lazear says.

However, few people truly understand the fundamentals.

That’s where an employee stock ownership plan comes in.

November 08, 2019

Central Ohio energy company goes employee-owned

Utility Technologies International Corp., a Groveport-based company that works in management, engineering, construction, operations and maintenance of natural gas pipelines and infrastructure, has completed a transition to employee ownership.

The company, founded by CEO Richard "Dick" Dickerson in 1992, is now controlled by the 69 people who work there.

Several of UTI's former shareholders will stay on as management in the company. But as he was considering succession planning, Dickerson said he saw an employee stock ownership plan "as a way to not only capitalize on their investment but ensure the cultural legacy of the company."

"Once we understood the benefits available to us and our employees it was clear this was the best path forward," Dickerson said in a statement.

Columbus-based investment management firm Lazear Capital Partners Ltd. structured the transaction and served as financial advisor for the company...

November 04, 2019

UTI Sells Company To ESOP Trust

Utility Technologies International Corp., a service provider to the natural gas pipeline industry, has sold 100 percent of the company to an employee stock ownership plan trust. The selling shareholders, led by majority shareholder Dick Dickerson, saw an ESOP as a way to not only capitalize on their investment but ensure the cultural legacy of the company.

With several shareholders staying on as members of management, UTI felt it was imperative to consider an option that best allowed the company to continue to grow organically.

UTI, located in Groveport, has been operating since 1992.

Lazear Capital Partners, an investment banking firm in Columbus, was engaged to arrange the transaction and serve as the company’s financial adviser.

June 20, 2019

Merchant Banking Firm Expanding in Arena District

With a wide range of businesses in transition, an Arena District-based firm that helps owners sell their companies is busy these days.

Lazear Capital Partners Ltd., a merchant banking firm catering to mid-market companies, is expanding to a 7,300-square-foot office on the second floor of 401 N. Front St.

 

The move represents a nearly 70% increase in square footage from its current home in the same building, and is a result of its growth.

 

The 20-year old firm, founded by partners Bruce Lazear, Michael Morosky and Ted Lape, now has a local staff of 15, including recently hired attorneys, CPAs, and executives with tax and transaction expertise.

"We've been growing like crazy," Morosky said.

The company, which has sales offices in Cleveland and Detroit and wants to expand further. It's considering additional sales offices in Atlanta, Cincinnati, Pittsburgh and Indianapolis. The new space in Columbus will give it breathing room to expand its staff further, though it doesn't have definite hiring plans.

Lazear offers services including merger and acquisition advisory, turnaround advisory, corporate finance and litigation services.

It's seen particular growth in conversions to employee stock ownership plans, or ESOPs, Morosky said. In five years, the firm has completed more than 40 major business transactions, half of them ESOP deals.

 

In an ESOP, the owner sells stock back to the company, which in turn allocates shares to employees. Once an employee retires or goes on disability, they're able to cash out. It keeps the company privately owned but still meets the owners' financial needs and provides a cash flow to the business.

And it's mutually beneficial – employees' stake in the company grows over time, helping with retention, while the company is also less likely to move as could happen if it's bought by someone from out of town.

Still, Lazear Capital is agnostic to the kind of transactions it does, and having an adviser has helped business-owner clients make a move on selling their businesses. That's something they are at times hesitant to do otherwise, Lape said.

"They're often worried that selling to a competitor or private equity will mean a loss of jobs or that they'll be put out of work," he said. "Our message has resonated with people. When we talk to clients about potentially selling companies, they like the concept of selling to a third party or selling to employees."

Lazear Capital’s Ted Lape On Transparency, Creativity And The Rise Of ESOPs

Lazear Capital Partners isn’t afraid to deliver bad news to business owners who want to sell.

“We do a ton of education for sellers for free because we don’t want to take money from someone who doesn’t understand what they want to do,” Partner Ted Lape says. “Sometimes we do an enormous amount of work upfront, just to tell people they shouldn’t do a deal.”

People appreciate the firm’s honesty and groundwork, and the effort often turns into referrals...

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