Given the unique advantages of Employee Stock Ownership Plans (ESOPs), it’s not surprising they are increasing in popularity. However, one surprising trend we have observed is an increasing number of owners of family-owned businesses considering an ESOP as an ownership transition tool.
The difficulty of transitioning a family business to the next generation is well-documented and, while there is no “silver bullet” to solve this issue, we believe an ESOP may be the ideal tool for transitioning ownership in many family-owned businesses. This article describes how an ESOP could solve some of the most common succession-related issues family-owned businesses struggle with, including:
- Preserving the legacy of the family business.
- Maintaining family control/influence.
- Monetizing the investment for existing owners.
- Estate planning with family business.
- Lack of NextGen family leadership.
Keep reading to learn more.
Succession Planning Challenge #1: Preserving The Legacy Of The Family Business
Succession Challenge: Many family business owners have spent a lifetime building their businesses, developing a family-oriented culture, and being leaders in their communities. There is often an unwillingness to sell to a larger acquirer or private equity investor due to fear that a new owner could jeopardize the company’s culture, quality, reputation, or position in the local market.
ESOP Solution: With ESOP ownership, family business owners ensure there are no required changes to leadership, operations, etc. after the sale; the name of the company remains intact; the culture doesn’t necessarily change (although the empowerment of employee ownership often leads to an improved culture); there is no disruption for customers, suppliers, or key business partners; and the company is not relocated. In short, nothing changes except ownership.
Succession Planning Challenge #2: Maintaining Family Control/Influence
Succession Challenge: Most owners of family businesses want their company to stay in the family. Therefore, maintaining family control of the business and passing the reigns to the next generation is often the primary goal.
ESOP Solution: A critical and often misunderstood advantage of ESOPs is while an ESOP allows current owners to transition ownership, the family can (and typically does) remain in full operational and strategic control of the company after the sale, even when 100% of the shares are sold to an ESOP. Simply put, the family-controlled business remains a family-controlled business after the sale to an ESOP.
Succession Planning Challenge #3: Monetizing The Investment For Existing Owners
Succession Challenge: Since the family business is typically the largest asset current owners of family businesses hold, it’s often challenging to balance the current owners’ needs to monetize the family-owned business with the desire to pass the business on to children or others who often cannot afford to buy ownership or are unwilling to assume the debt required to buy-in.
ESOP Solution: An ESOP is a unique vehicle that allows family business owners to exchange ownership for fair market value yet remain active in (and in charge of) company operations. Owners typically receive fair market value in the form of (A) a cash down payment (often from a bank or using excess company cash) and (B) an attractive payment stream from a note for the balance of the price (often with an attractive interest rate and/or warrants to provide upside). Additionally, there is favorable tax treatment for shareholders who sell to an ESOP. ESOPs offer the gradual transition that many family business owners desire, while allowing the selling shareholder(s) to monetize their investment and diversify their wealth as they transition toward retirement.
Succession Planning Challenge #4: Estate Planning With The Family Business
Succession Challenge: When it comes to estate planning, most owners of family businesses have two primary goals: (A) equalize the inheritances of all family members, including those who are active in the business and those who are not, and (B) ensure family members with business leadership potential have the opportunity to run/control the family business. The most common challenge is that since the family business is typically the largest asset in a family’s estate, it’s difficult (if not impossible) to transfer ownership control to one or a few key children while keeping inheritances equal for children who are not active with the family business.
ESOP Solution: An ESOP is an outstanding solution. By converting an illiquid asset (i.e., ownership in the family business) into cash (and a payment stream that quickly turns into cash), estate planning becomes much easier. All inheritances can easily be equalized using the proceeds from the sale of the business, and family members who are active with the business (especially those in leadership roles) no longer need to balance the needs of non-active family members; rather, their sole focus will be on growing the company and making decisions that are in the best interest of the company.
Succession Planning Challenge #5: Lack Of NextGen Family Leadership
Succession Challenge: Oftentimes, family business owners are ready and willing to transition leadership, but family members aren’t willing or able to step into a leadership role. Since maintaining success, profitability, and growth of the family business is typically priority #1, the lack of capable NextGen leadership is often the beginning of the end of a family business.
ESOP Solution: ESOPs may be a perfect solution in this scenario as it’s an ideal gradual transition tool, as existing owners (family and non-family managers) can slowly phase out of leadership but maintain strategic and operational control for as long as they wish. Oftentimes, non-family members are the best individuals to manage a family business. Furthermore, many family businesses have long-tenured key managers and employees who are viewed as “extended family” due to their many contributions to the family business. Doing right by these non-family employees is often a key concern during the succession planning process for family business owners.
Summary
Owners of family businesses encounter countless challenges in succession planning for the family business. In attempting to solve these challenges, the family often wants to make the best decision for the company, because without the continued growth, profitability, and success of the family business, it may be impossible to achieve other objectives. Numerous studies demonstrate the success of ESOP-owned companies, and owners of family-owned businesses may be wise to consider an ESOP as an ownership transition alternative.
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Sign in to our Member Information Center to watch Brian Bornino's full webinar on ESOPs: What’s all the Buzz About? for a comprehensive overview of ESOP's and how they can business owners achieve liquidity, preserve their company’s legacy, reward employees, and implement a successful long-term succession strategy.
Thank you to GBQ Capital Advisors for providing this valuable information. GBQ is a nationally recognized authority on ESOPs, empowering the growth of 100+ ESOP companies annually across the country. With specialized expertise in feasibility studies, formations, transactions, and valuations, GBQ has guided numerous businesses through the intricate process of ESOP implementation. For questions about ESOPs or to discuss your situation, contact Brian D. Bornino, CPA/ABV, CFA at bbornino@gbq.com or (614) 307-4388.
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