ESOP Pros and Cons

Is an ESOP Right for Your Business?

There are pros and cons to every business strategy and Employee Stock Ownership Plans are no exception. True North Business Navigation Professionals help inform business owners about ESOP pros and cons, and how participants can benefit.

ESOP Pros

EXIT STRATEGY WITH FLEXIBILITY

An ESOP can be an excellent exit strategy for an owner who wants to sell his/her business. It has the flexibility to allow the owner to maintain control and continue operating the business while achieving liquidity. An ESOP allows for either a gradual or an all-at-once divestiture of ownership.

DEFERRED CAPITAL GAINS

A special provision known as a 1042 election can enable the selling business owner to defer capital gains tax on the sale indefinitely.

REDUCED INTEREST LOANS FROM BANKS

Companies may qualify for ESOP loans with a reduced interest rate from banks because these lending institutions receive ESOP-lending tax advantages.

REDUCED STRESS – HIGHER RETURNS

Using an ESOP as an exit strategy rather than an outright sale to a third party is much quicker, less time consuming, less stressful, and usually nets out as much or more for the selling owner.

ELIMINATE S-CORP TAXES ENTIRELY

Subchapter S Corporations can have ESOP’s, creating the potential for complete elimination of federal and state income taxes at both the corporate and shareholder levels.

ESOP Cons

ESOPs are not always the best solution for a business exit strategy. A very important issue to understand is that an ESOP is only a mechanism for the sale of a business, and it is not a succession plan. Having a clear, well-thought-out succession plan greatly enhances the probability of success for an ESOP.

ESOPs rarely get the positive media press that they deserve.  Misconceptions, lack of understanding, and occasional misuse of ESOPs continue to be deterrents to their utilization.

ESOPs have been used in severe distress situations with the hope that they would be the silver bullet to fix everything. This use of an ESOP should be highly discouraged.

Another potential problem area is when a business has an extremely high value in relation to the size of its workforce or annual payroll. This occurs sometimes with highly profitable service businesses that require a relatively small staff or workforce. The potential challenge in these cases is that it may take more years for the ESOP to buy out the owner than with what he/she is comfortable.


 

 

 

 

 

Is an ESOP a good fit for your company?

Contact True North Business Navigation Professionals