EDGEMONT CAPITAL BLOG
Reasons to Consider an ESOP
For smaller enterprises, employee stock ownership plans (ESOPs) have always been a good option. Now, middle market entities are considering them as well. Companies that can easily sell to private equity are increasingly choosing ESOPs instead. ESOPs allow employees to purchase an interest in the company while offering the owner significant liquidity. ESOPs can be a great option for realizing value while offering a significant retirement benefit to employees. So should your firm consider this potentially beneficial option? Here are some factors to weigh.
ESOP: Leave a Legacy
ESOPs offer compelling tax benefits and that might seem like reason enough. This benefit just scratches the surface of an ESOPs benefits and can be highly lucrative for the seller. They offer fair market value, but are unlikely to match the high multiples a seller can expect from private equity. In fact, dissolving the company and selling the assets may offer a larger return.
A company is more than a sum of its parts, though. Many owners have put years of their life into their business. An ESOP is a great way to preserve that legacy of hard work when money’s not the only important factor. It allows staff to secure a retirement investment through their work and ownership. Owners can take care of their employees and themselves, preserving the family spirit that is such a key part of many small to medium-sized businesses’ success.
ESOPs are flexible, making them a good option for owners who feel emotional or anxious about selling their business. A skilled advisor and legal counsel can help you work out incentive plans to promote good performance and ensure that the owner receives a set amount of money. Some sellers become creditors through seller financing, potentially allowing them to reap greater rewards down the line. Structuring these deals can prove challenging to novices, so it’s important to seek experienced advice from a team of experts.
Risks to Consider
An ESOP can offer great benefits to sellers and employees alike. That doesn’t mean this option is perfect, or that it’s for everyone. These plans tend to work best for companies that have heavily invested owners and a committed staff. They’re often family owned or closely held corporations. The company should also have a strong and tenured management team with the skills necessary to run the business following an exit. If the owner is too involved in daily operations, an exit can tank the company.
The company must also have a base of good collateral with healthy margins that can be borrowed against. The business should be solid, with steady growth—not many peaks and troughs.
ESOPs can be a great option for many, but all deals can go wrong when poorly structured. With a valuation that is too high or a volatile covenant with lenders, the deal can quickly turn upside down. Perhaps most importantly, the owner must truly be prepared to transfer control. Otherwise, they can run afoul of the rules governing the ESOP. A reliable board or other governing mechanism must be in place to ensure good governance and compliance with the terms of the ESOP.
About Edgemont Capital
Edgemont Capital Partners is a specialist healthcare investment banking firm. We focus on the needs of founder-owned and entrepreneur-run healthcare and life sciences companies in the lower middle and middle markets. Our world class transaction expertise is a result of our extensive and proven track record of success. We have advised on over 125 transactions representing more than $35 billion in combined value.