As a business owner you may be asking yourself how to keep your employees motivated and focused on the long-term objectives you have put in place for your business or you may be asking yourself how to raise additional capital to grow your business. There is a way to keep employees focused and aligned with the company’s growth objectives. Growing up in a family of entrepreneurs, I was always told that you better care of the things you actually own. Ever been to a nice hotel room and left the beds undone? The point here is that if employees take ownership of the business, they will have the business’ best interests at heart. One of the mechanisms used by many business owners as an exit strategy is an ESOP. An ESOP allows the continuity of an existing business and can be a great way for growth and expansion.
Employee Stock Ownership Plan, or better known as an ESOP, is an employee benefit plan much like a 401(k) that allows your employees to take a real interest in the success of the company ownership. In other words, employees are allocated a number of ownership shares in a business this making them ‘owners.’ Traditionally, when the process of an ESOP begins, ownership shares are usually held in a trust until the employee decides to retire or leave the business, and at that point the company buys back the shares, keeping the ownership under one roof. The best part is the shareholders of your company wouldn’t be some outside investors that are only focused on their return, but they would be the people coming to the office everyday and putting in the work to make a difference. The success of your business will directly affect your employees/shareholders retirement plan, giving them an additional reason to increase productivity and profitability.
Now, let’s say your employees are doing great but you want to take your business to its next growth stage. You may go to a bank to obtain a loan, which will result in high interest rates for a number of years. Your second option may be to seek out a financial investor, that could potentially result in losing a majority or controlling stake in your company. When companies bring in investors, they will want to see a return on their investment as quickly as possible and this can cause unwanted changes in company culture or operations. Luckily, there is a third option, creating an ESOP. This would allow you and your employees to stay in control and maintain the corporate culture you have created for your business over the many years it’s been in operation.
You’re probably thinking how does an ESOP create capital for my company. At a simplified level, the business will have to be able to borrow money from a financial institution to fund the transaction of buying company shares or shares of a current owner. Since this would be considered a loan, the business will have to pay back both principal and interest; however, the way an ESOP is set up is as a pension plan, if you speak to your CPA or tax advisor they might be able to guide you on how these contributions could alleviate your tax burden. In addition, to the contributions to repay the ESOP loan, your tax advisor might be able to illustrate that there are other tax benefits the company can benefit from. Some of these include, cash contributions to the ESOP for the purpose of buying shares from employees or even to build up cash reserves could be tax deductible. In S Corporations, the ownership held by the ESOP could be subjected to tax benefits, as the proportion held by the ESOP does not have to pay federal income tax. For example, if the ESOP owns 30% of the company, 30% of the profits from the business will not be included when paying taxes. There are restrictions on all contributions but these seldom cause an issue for the company.
You may be asking yourself, ‘why would my employees would want a stake in the business?’ ‘it’s just a job for them.’ Well the answer to this is that there are many benefits for the employees to participate in an ESOP. Just like most pension plans, the employee will not pay taxes on these contributions as long as they are working for the company. Instead of giving additional bonuses for hitting goals, which are taxed, you would be able to offer shares in the company and in the end will benefit them when they reach retirement. In a study in 2017, millennials that are in an employee stock ownership plan reported 33% higher wages, 92% higher net household worth, and 53% longer median job tenure.1
As a business owner who values the safety and well-being of your employees, before you decide on management buyout to increase capital or step away from your business, consider all the options on the table. Benchmark International a leading lower middle market M&A firm is able to assistance you in this process when making tough decisions on the future of your company. We are here to support our client’s objectives and make an easy and graceful transition as you prepare for the step stage of your life, no matter where that might be.
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