In today’s business climate, business owners considering liquidity are facing challenging times in the marketplace. The reason: fewer buyers, with those active in the marketplace being more discerning in their acquisitions. In addition, businesses are receiving lower valuations compared to the historical values companies received a few years ago. And, it is most unlikely that high values will return to those record highs in the near future.
Facing this, how can an owner gain liquidity at their perceived market value? An excellent avenue is an Employee Stock Option Plan (ESOP).
ESOP Valuations: Valuations of a company selling to an ESOP are often higher than the value an owner might receive selling to a third party. The reason is that ESOP acquisitions are assigned an enhanced value is the reliance on the discounted cash flow methodology used in ESOP valuations. This is especially true in current times when market multiples are soft.
ESOPs Are Transaction Friendly: The timing to organize and close an ESOP can be accomplished in as little as sixty (60) days. This compares to selling a company that can take up to four to eight months to closing. In an ESOP, owners do not have to expose confidential operating data to potential buyers who may also be competitors. And, employees are usually motivated with the creation of an ESOP instead of being concerned when they find out that their company is for sale.
Capital Gains Deferral With ESOPs: One of the primary features of an ESOP is the opportunity for the selling shareholder to defer capital gains tax. So long as the ESOP owns 30% of the company going forward, the selling shareholders can claim the capital gains tax deferral relief. Because an owner can defer its capital gains with an ESOP, this type of transaction has a built in premium over selling to a third party.
Othe ESOP Benefits
- Retain operational control, if desired
- Transition management over time
- Ability to sell a portion of the company (minimum 30% to achieve favorable tax benefits)
- Ability to use pretax dollars to repay ESOP debt
- Reward and motivate employee base pay with ownership in business
- A full sale of the business to a third party can be executed anytime when market conditions might prove more favorable
Finally, with interest rates hanging near historic lows, the cost of capital for a leveraged ESOP is compelling. While banks have retrenched in many sectors, many remain aggressive ESOP lenders in today’s market.