2024 is poised to be another strong year for employee stock ownership plan (ESOP) transactions, with deal volume expected to eclipse 2023’s (reaching toward the highly favorable dynamics of 2021 and 2022), thanks to four key underlying drivers that should push through any economic or political uncertainty:
Here’s why, amid an anticipated upward move in mergers and acquisitions (M&A) volume, selling to an ESOP is a remarkably effective move for business owners like you—in any year, but especially in 2024.
Selling your company to an ESOP can satisfy multiple constituencies simultaneously, owing to the ESOP’s unique aspects that benefit you, your employees, and the company itself. As a business owner, you can transition on your own timeline, as you could initially sell only a minority position, while eventually selling all of your stock (if you decide to) while continuing to run the company and participate on the board. You can also save on taxes: selling to an ESOP allows you to defer or eliminate all capital gains taxes. What’s more, your employees will gain an ownership stake in the business without contributing any personal capital. With company and employee incentives aligned for the long term, employees also realize greater job satisfaction and security. And your company will not only solve one of its biggest problems—achieving stability by confirming who the next owner will be—but also increase its cash flow: by operating on a tax-advantaged basis, the business could avoid paying income taxes ever again.
While most M&A transactions are driven by strategic needs or economic forces, ESOP transactions predominately occupy the lower middle-market, where the personal needs or desires of the company owners—including factors like age, family dynamics, and health—play a more significant role than the economic cycle. The “silver tsunami” discussed for more than a decade has started to prove out in transaction volume, with baby boomers (whose birthdays this year will make them between 60 and 78 years old) overwhelmingly beginning and/or completing the transition of their business. The COVID-19 pandemic made clear that a company’s value can change quickly, and most boomers do not have the luxury of time to recover lost value over another cycle.
An ESOP is an exceptionally attractive succession option for boomer owners seeking a gradual transition out of the business, allowing them (as described above) to sell stock in smaller increments while remaining at the company. Plus, the emphasis on wealth-sharing strikes a chord with owners who place greater value on their employees than previous generations did—and the potential for higher net proceeds appeals to owners who are likely to live in retirement longer than their predecessors.
Many financial experts believe the Federal Reserve’s unprecedented series of rate hikes in 2022 and most of 2023, which significantly increased the borrowing costs for businesses, was the primary contributing factor to a decrease in M&A transactions for 2023. The impact was also noticeable on the level of ESOP sales, which rely on the debt markets to facilitate the liquidity event for sellers. Recently, the Fed signaled a forthcoming decrease in rates; combined with companies’ growing comfort with operating amid higher-priced debt, this will further encourage sellers to consider the ESOP option.
Improved valuations will likely be another significant factor in increasing ESOP transaction volume this year. The S&P 500 rose by 23.79% in 2023, creating excellent momentum in company valuations as we begin 2024. Of course, a number of factors go into the valuation of your privately held company, but the stock market is generally a good indicator of valuation trends for ESOP transactions.
One significant post-COVID trend has been the increased stake in profits and success that employees now demand from employers. Recent strikes have shut down major automakers and the movie industry; walkouts by airline pilots, UPS drivers, and others signal their desire for a bigger stake in the company’s success. Privately held, middle-market companies may not encounter the same headline risk, but similar factors could be causing dissatisfaction among your employees all the same.
The entire ESOP concept is based on sharing equity upside with all or most of your employees—an idea that has worked since 1974 and that ESOP companies will continue to get right in 2024, especially as millennials become more influential in the workplace. Aligning company and employee incentives will encourage your workers to be more productive, setting the foundation for increased loyalty and building the enhanced culture required for long-term success.
An ESOP provides tax advantages by statute and can even be totally tax exempt—benefits that are intensified in a rising tax-rate environment. Although a presidential election year is generally tricky from an economic forecasting standpoint (and even more so given our current political environment), prognosticators agree that significantly reduced taxes are unlikely soon—and indeed we may see an increase based on the cost of COVID-related aid and the increase in the national debt. In the midst of such uncertainty, the flexibility of an ESOP can be an advantage, regardless of your political affiliation. The ability to sell a minority piece of your company to an ESOP and retain control while personally diversifying is a tax-advantaged hedge that only an ESOP can offer.
In 2024, as you envision innovative ways to drive your company forward, embrace the ESOP option as a crucial element of your business strategy—not just a retirement benefit plan, but a true game-changer. Now more than ever, this strategic tool can empower your employees, strengthen your culture, and position your company for robust growth in the ever-evolving business landscape.
Discover how an ESOP can be the right strategic move for your company by contacting PCE today for a confidential consultation on unlocking its full potential. Make this the year you unleash the formidable power of an ESOP.