As a business owner, there comes a time when you’ll want to start thinking about your ideal exit strategy. You’ve built your company, watched it grow, and now it’s time to capitalize on your business assets, increase your personal liquidity, and diversify your investments.
The good news is that it doesn’t have to be an all-or-nothing exit scenario. Many business owners prefer to keep control of their company while still receiving the financial benefits of a traditional M&A transaction. Others want to ensure the stability of their employees’ jobs and preserve their business legacy while selling a portion of their equity shares. For these owners, an ESOP is an attractive exit and succession planning vehicle.
ESOPs allow owners to determine the exact percentage of shares they sell – typically from 20% up to 100% of their shares, define their role in the company going forward, maximize their tax benefits, reward their loyal employees, and keep their business culture intact.
Here are four of the best reasons to consider a partial ESOP transaction when planning your business exit strategy.
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ESOP Tax Benefits
A partial ESOP sale allows you to sell a portion of your stock – typically from 20% up to 100% – and avoid the capital gains taxes you would otherwise owe on the sale. A partial ESOP company structured as an S-corporation does not have to pay federal income taxes on stake owned by the ESOP. For example, if an ESOP owns 40% of your company stock, then 40% will not be taxed. Taxes are then deferred until participants withdraw ESOP funds, enabling the company to accumulate cash for future transactions and growth.
As a C-Corporation, you would need to sell at least 30% of ownership shares to get the tax benefits of a 100% transaction. If you do that, you can then defer the capital gains tax on the sale by following the guidelines set by Section 1042 of the IRC. All while retaining a majority stake in your company.
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ESOP Ownership Culture
Another benefit of a partial ESOP sale is that it can preserve the business culture you’ve built and create an enhanced “ownership culture” within your company. An ESOP acts as an additional retirement incentive to employees, providing them with contributions in individual ESOP accounts. It gives employees a stake in the company, allowing them to directly see the benefits of their performance.
The better the company does, the better the employees’ accounts do. It can help align the goals of management and of employees – not always an easy task without an ESOP. Plus, companies with ESOPs tend to statistically perform better on average.
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Ownership Wealth Diversification
One of the main reasons you might be looking to sell is that you want to diversify your assets and reduce your personal exposure to your business financials. Selling a portion of your company stock to an ESOP allows you to receive proceeds and invest in alternate sources of wealth. All while you are still the majority owner (if you choose to remain so), and while you retain ownership shares that gain even more value as your company continues to grow.
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Retain Ownership Control
Selling a minority stake of your company to an ESOP allows you to retain the majority of equity in your company. You stay in control of your organization, while also gaining the proceeds from the sale. You can continue to drive your company toward a higher value, all while watching your company and employees prosper under the ESOP.
The fact is, you didn’t grow your company overnight, and you may prefer to gradually transition ownership over time instead of all at once. Selling a partial stake to an ESOP allows you to diversify your financial assets, gain valuable tax advantages, and provide meaningful employee benefits all while still retaining control and majority equity in your business. And, if over time you do decide to sell outright, you can sell the rest to an ESOP or to a third party, meaning more financial gains for you and your employees in the future.
