Selling to an ESOP: What’s Up with That?
Mark Twain? Will Rogers? Surprisingly enough, no one actually seems to know who first coined that pithy comment. (See https://wellnowbob.blogspot.com/2008/07/it-aint-what-you-dont-know.html). Whatever the source, it’s a sentiment that fits when it comes to ESOPs.
There is a lot of misinformation circulating about ESOPs. This is the first in a series of posts that will aim to set the record straight. Who am I to take this on? I’ve been working with ESOPs since 1984. I served as deputy director at the ESOP Association trade group. Worked at the Labor Department where ESOPs are regulated. Headed up human resources at a foodservice company in Silicon Valley. And since 2000, I’ve been with the Beyster Institute, an organization founded by entrepreneur Bob Beyster and now part of the business school at the UC San Diego. Credentials established? Let’s jump in!
There is a ton of research showing that, done right, putting stock ownership in employee hands leads to higher profits, faster growth, improved productivity – and improved wealth accumulation for employees too. ESOPs (employee stock ownership plans) certainly do that. But that’s not the biggest reason that business owners use them.
At least 30,000 companies have created ESOPs since 1975 – nearly all at private firms. And the great majority of those ESOPs got started because the owner wanted to turn some of his or her “on paper” equity value into actual, liquid cash – and do so on highly tax-favored terms. That’s what ESOP’s are good for, in a nutshell: yes, boosting company performance and giving employees a chance to build wealth; but even more so, enabling a company’s owner(s) to sell off any portion of their ownership they may want to liquidate, while minimizing taxes.
So What Exactly Is an ESOP?
Technically, an ESOP is simply an employee retirement plan – a “qualified” plan eligible for special tax treatment. But in actual use, an ESOP is much more. The function of an ESOP is to buy company stock and hold it as a retirement investment for the company’s employees. To facilitate this, ESOPs are authorized to borrow money to finance stock purchases. This means that if you own a private firm, you have a way to sell that stock – whether just a few shares, a major portion, or the whole enchilada.
That’s myth #1 to bust: there are no rules prescribing how much stock you can sell to an ESOP. Whether 1 percent or 100 percent, that’s a decision the ownership gets to make.
What Advantages Does an ESOP Offer?
- Selling a part interest. With other buyers, a sale is likely to be an all-or-nothing proposition – sell them the business or don’t sell it. With an ESOP, you can sell any portion of the company you want.
- Big tax advantages. As a rule of thumb, a stock sale to an ESOP can produce tax savings that equal the entire price paid by the ESOP for the stock. So, if an ESOP purchases $1 million of stock from you, that will generate about $1 million in tax deductions/deferrals.
- No adversarial buyer across the table. You get to control the terms of deal. Set up a sale when you want, in the amount you want – however you want to proceed, limited only by the law, not what an adversarial buyer is demanding.
- The company gains a strong future. Sell out to an ESOP, and the company (and your employees) continues to operate with a promising future. Sell to a conventional buyer, and your firm may be merged, moved or otherwise torn up, ceasing to exist as an independent concern.
All this requires more explanation. And that’s what future posts on this blog are for. So stay tuned – more to come!
Next week’s topic: What Exactly Are the Tax Savings Available through an ESOP?
Martin Staubus is a principal at the Beyster Institute, part of the Rady School of Management at the University of California, San Diego. The Institute was established by entrepreneur Bob Beyster, who founded and built SAIC, a Fortune 500 company. https://www.rady.ucsd.edu/beyster/