I’ve been thinking about ESOP’s and their use in the private business world for the past several days. The overriding thought that I’ve been having is that an ESOP is not an exit strategy. It is a transition strategy.
Most people when they establish an ESOP in their company are not going to want to ride off into the sunset. Well, they may actually want to ride off into the sunset, but they don’t. The reason for this is most of the time the selling owner doesn’t actually get to sever relations with the company. They often will either be holding a significant amount of paper or debt from the ESOP or they will have used the proceeds they get from the sale of their business as collateral for the ESOP loan the company has received.
Either way, the owner is still at the very least extremely interested in the successful operation of the company.
This reality leads me to the conclusion that selling owners should not think of ESOP’s as an exit strategy. Most of the time the selling owner will be sticking around for five to seven years while their note or the bank loan is being paid off.
I also find it interesting that many times ESOP’s have a life span of about seven to ten years. The owner has gotten their money out of the company, but successor management who can successfully run the company hasn’t been developed. The ESOP committee really has no choice in this situation but to look for a buyer of the company. If they don’t, then the ESOP particpants (the company employees) might be left with an asset that has no value.
The thought crossed my mind that ESOP’s conceptually are a great thing. I think that if we work with the owners of the company to change their thought pattern from one of a succession strategy to one of a transition strategy we might have more ESOP’s that last past the end of the selling owners interest in the business. If we can get the selling owner to change their concentration from operations in the company to developing a management team who can take the company past the selling owners involvement, the long term results of the ESOP companies might be more positive.
I know I for one will start incorporating transition planning as part of the ESOP work that we do. I’m hopeful that by changing the focus of the selling owner we can have more ESOP companies last for multiple generations. This will involve a change of focus from one of concentrating on day to day operations to one of focusing on the future and what the organizational chart will need to look like for success. Hopefully, this change in focus will see more ESOP companies last for multiple generations.
Josh Patrick
Filed under: Ethics, Exit Strategies, For Business Advisors, For Business Owners | Tagged: ESOP, succession planning, transition planning
Mr. Patrick’s take on ESOPs make a lot of sense, but I would add some caveats. First, the level of ongoing involvement varies considerably from interested observer with a potential exposure if the ESOP does not repay the debt to an active manager. Companies with strong successor management have less need for the former owner to stay actively involved, and many have no desire to do so.
Second, ESOPs are a very successful transition strategy. Bankruptcies are very rare, and research at Rutgers, as well as the National Center for Employee Ownership, show that post-sale, ESOPs actually grow faster than would have been expected based on their prior performance relative to competitors and are more likely to stay in business longer.
That leads to the third point, which is that is not true that ESOPs often only last seven to ten years. Changes in tax laws make it very, very appealing to stay ESOP long-term by becoming a 100% ESOP company, in which case income tax no longer is paid. ESOP termination rates are now lower than for other benefit plans and ESOP companies are less likely to be sold or go out of business than comparable companies. That is not to say Mr. Patrick’s scenario never happens; it just is no longer than common.
Details on ESOPs in general and the research in particular can be found on the web site of the National Center for Employee Ownership (my organization) at http://www.nceo.org
Corey Rosen
Executive Director
National Center for Employee Ownership