By Andrew J. Kulesza, Vice President & Middle Market Relationship Manager, Fifth Third Bank
As if every season of the year is a good time to talk ESOPs, surely the holiday season would be appropriate. ESOPs (Employee Stock Ownership Plans) provide eligible participants beneficial ownership in the Company at no cost to the employees. Depending on a number of factors, employees may be allocated shares annually.
The elves create this magical gift when a business owner decides they want to sell their business at some point over the next several years. He or she would speak to their banker and Business Transition Advisory Team to begin the process of researching options for sale. If sold to an ESOP, the owner on occasion can sell at less of a multiple than to a non-ESOP and still come out ahead given the tax advantages. One of the tax advantages can be achieved by paying zero capital gains tax if the C-corp elects a 1042 transaction and proceeds are reinvested in qualified retirement assets. To obtain tax advantages, as little as 30% of the Company can be sold. That is no Jelly of the Month club, Clark! (Speak with an attorney experienced in ESOPs as well as your tax advisor.)
Once settled on an ESOP, the business owner has the opportunity to continue running the business for as long as the board of directors and the former owner see appropriate, which makes the ESOP a viable option for owners at any age.
The gifts keep flying down the chimney. Post transaction, under certain conditions, if the Company elects to be an S-Corp, it will operate paying no Federal or State income taxes after New Year’s Eve. In lieu of taxes, the excess cash flow can be used to fund retirees as they put the shares back to the ESOP. Over a recent ten year period, over a trillion dollars has been distributed in ESOP benefits.
Selling your business to employees is not just a gift for the buyer and the seller. The ripple effect on the local economy benefits us all as well. Many times when a business is sold, local jobs are lost and negative impacts are felt throughout the community. When selling to an ESOP, the restaurants, cleaners, coffee shops, and other local businesses do not miss a penny. An ESOP company is a key vehicle for worker retention. In fact, research shows ESOP employees have higher wages than non-ESOP owned companies and the wealth gap grows smaller.
Look over in your stocking for these data points from various studies:
- ESOP participants have more than two times the average retirement balance of Americans nationally.
- Workers ages 28-34 who worked in an ESOP company had 92% higher household net worth, 33% higher median income from wages, and 53% longer job tenure than non-ESOP workers in the same age demographic.
- On average, productivity increases 4-5% the year an ESOP is adopted.
- When an ESOP company has participative management and workers are empowered, data shows an 8-11% per year faster growth rate than non-ESOPs, or those where the culture does not promote active engagement by their employees.
- Over a 10 year period, privately held ESOPs were only half as likely as non-ESOP firms to go bankrupt.
- Employee owners of color earned 30% more than non-employee owners, and female owners earned 24% more than non-employee female owners.
- The median wealth of Latinx ESOP employees is nearly 12 times the wealth of the national median. Black ESOP employees have approximately three times the wealth of Black households nationally.
If you are one of the millions of business owners thinking of succession, even if it is 5-7 years away, you can talk about ESOPs at your holiday gathering this season. Who knows, by this time next year, your employees and family might be calling you Santa Claus.