Family-owned businesses are the heart and soul of the American economy. And when it comes time to retire and pass the company on to your children, succession planning is key.
But sometimes, family business planning can get tricky. Not only do you want what’s best for yourself in terms of liquidity, and the company in terms of future growth – you want what’s best for family harmony, too. And with your family name attached to the business, you don’t want to sell to just anyone. One option is selling to an ESOP.
Selling your business to an Employee Stock Ownership Plan (ESOP) can help ease some of the common issues that arise with family business succession planning. It can be succession planning tool that allows an owner to determine their liquidity and control, lets you preserve your family legacy, and provides a potentially life-changing benefit to employees.
In this article, we will discuss the main reasons why an ESOP sale can help avoid issues and make sure everyone in the family gets their fair share.
Selling to a Third Party is Unpredictable
Selling to a third party – whether an outside company, or even your children – comes with a measure of unpredictability. Plus, the capital gains tax repercussions can cut into the sale price and reduce liquidity for you, and potentially for your children down the road. And that could be the case even when all parties agree!
Conversely, an ESOP sale offers flexibility that a normal sale cannot. An ESOP sale gives you liquidity, a deferral on the capital gains tax, and the ability to stay on in your desired capacity.
If you have multiple children, they may not have an equal interest in carrying on the family business you have worked hard to build. And the last thing you want is to cause potential conflicts between siblings. You want everyone you care about to have an outcome that is equitable for everyone.
Selling to an ESOP can help with this. The ESOP is the buyer, and the seller gets liquidity from the sale. From there, you can choose to incorporate purchase warrants for your children who want to be involved, while the children with divergent interests could get gifts of equivalent value. Therefore, both the uninvolved and involved children get something of value.
Retain Some Control
You might want to retain some control in your business or at least have a smooth transition out, knowing that your children are adequately prepared to take over. An ESOP sale allows you to stay involved in day-to-day operations as much or as little as you please, because you can sell any amount of stake in your business – from 1 to 100%. It gives you time to prepare your children, and also prepare the company and promote the benefits of their new retirement benefit.
Selling to an ESOP rather than a third party has significant tax advantages. If you are a C-Corporation and you sell at least 30% of your business to an ESOP, you defer tax on the sale provided that it is reinvested in certain securities of U.S. operating companies under Section 1042 of the Internal Revenue Code. You are also reducing the company’s tax burden because the stock contributions made to ESOP retirement accounts are tax deductible.
If your business is set up as an S-Corp and becomes ESOP owned, the percentage of the company owned by the ESOP does not pay federal or state income taxes. Imagine if your company is a 100% S-Corp. ESOP and never has to pay corporate taxes again, allowing you to use those excess proceeds to pay down debt, fund CapEx, or make strategic acquisitions. This is called a super-charged ESOP Company.
Culture and Legacy
With an ESOP sale as opposed to a third-party sale, your company and your children still involved stand to gain cultural benefits. Employees in ESOP companies receive a share of ownership of the company, and they see the benefits in their ESOP retirement plans. This gives employees a personal and financial stake in the performance of the company, which leads to improved outcomes. And when you sell to an ESOP, it’s likely that you will keep your company name and remain locally owned.
Strong culture and employee investment make it likely that your business will continue to flourish for your children.
For these and many other reasons, selling to an ESOP can be a way to successfully plan for what comes next for your family business.
*Data from US Family Business Surveys