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January 22, 2018 How To

How To: 5 points to consider in deciding whether ESOP is right succession tool for your company

David Schneider
By David Schneider

Is an Employee Stock Ownership Plan the right succession tool for your company?

Last year Maine businesses continued to utilize an Employee Stock Ownership Plan as a succession planning tool that both provides liquidity to selling owners and incentives to loyal employees.

In recent years, several Maine companies in the construction industry have turned to ESOPs, including Johnson & Jordan, Landry/French, Wright-Ryan, Knowles and ReVision Energy.

In general, an ESOP is a trust that holds all or a portion of the company's stock for the benefit of employees. The owners benefit because the trust pays them fair market value for their shares in exchange for a combination of debt and cash. Meanwhile, employees are incentivized to remain with the company and support its growth because they continue to accrue shares in their account that may also increase in value over time.

Succession planning is an important step in every company's lifecycle. A business owner must determine who will take over the management and ownership of the business. In some cases, this means that a family member will take over. In other cases, the business owners will sell the business to a strategic buyer or management.

Some Maine businesses have determined that ESOPs are the appropriate succession tool because of the following reasons:

  • Timing: Baby boomer business owners who ran their companies for years or decades are beginning to think about retirement, which means finding new owners to take the helm. ESOPs offer a unique structure where the operation of the company can transition to the next generation over time.
  • Market conditions: Private capital to fund strategic acquisitions does not always make its way to Maine and New England. With ESOPs, the transaction does not require outside capital to fund the acquisition because payments to the owners can be made over time from the company's cash flow.
  • Tax benefits: Congress has implemented specific tax benefits to encourage ESOPs. If a company is a 100% ESOP-owned S-corp, it's likely that profits would not be subject to federal or state taxes.
  • Job protection: Many owners are concerned that an out-of-state strategic buyer will purchase a company's assets and layoff all or some of the employees. In the case of ESOPs, it is likely that the company's location will remain the same and most jobs will be preserved.
  • Employee ownership philosophy: Some owners feel loyalty to their employees for making their business successful. Such owners feel that rewarding employees with the economic benefits of ownership is an appropriate way to reward them for their success and loyalty.

Not all Maine businesses are well-suited for ESOPs. Companies with less than 10 employees or low cash flow may not be able to support the contributions required to operate an ESOP. Even if a business can support payments to an ESOP, there is a risk that the company is unable to support an ESOP due to market downturn. In addition, transitions can still contain pitfalls. For example, before owners retire, they must recruit and retain a strong management team to continue to operate the business.

All Maine businesses should consider succession planning. ESOPs are one option to consider along with strategic or inside buyer. More Maine companies have undergone an intense analysis process and determined that an ESOP is right for them.

David Schneider, a shareholder at Bernstein Shur, can be reached at dschneider@bernsteinshur.com

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