Rewarding Your Employees By Giving Them the Business

Retiring from your business is a tough decision.  To ensure that the legacy you’ve built continues on, you need a plan for succession.  For some people, they have spent years grooming a child or other family member to take over, wanting the business to stay in the family.  Others look to sell to a third party for a way out that will also give them a nest egg for their next phase of life.  However, there is a third option–transferring the business to your employees.  Your best employees are an integral part of your business legacy, and can be the best option to ensure that your vision is carried on.  If you like the idea of transferring your business to long-time faithful employees who have contributed greatly to the company’s success over the years, below are a couple of options for you to consider.

 

Management Buyout

This type of transfer is a process, not an event.  The management team comes together with financing and arranges a deal with you to buy the assets and operations of the business.  A management buyout has the benefit of being quicker and more confidential than a third-party transaction, and the structure of the deal can be more flexible.  There is also the added benefit that the legacy of the company will continue in the hands of those in management who have earned the opportunity to buy the business with his or her loyalty and hard work.

 

With this option, you may also be able to provide some continued service to the company as an officer and/or director.  In addition, you may even be able to continue in some part of the business that you enjoy.  You may even be able to keep some control over the company.

 

When considering a management buyout, some important factors are:

  • How much cash, debt, and earn-out will be involved?
  • When will the transfer of control occur?
  • If management has little or no capital, where will they get the money for the buyout?

 

Employee Stock Ownership Plans (ESOPs)

An ESOP is a qualified plan under the Employee Retirement Income Security Act of 1974 (ERISA).  Instead of selling directly to management, you are making the sale to the ESOP, which has been set up by the company.  The ESOP can either attempt to get bank financing to purchase the stock from you, or you can take a note for the value of your shares and have the repayment of the note arranged for internally.  The employees become plan participants, similar to other employee incentive programs and are entitled to benefits at certain points as determined by the terms of the ESOP.

 

This option is similar to a management buyout, but with potentially valuable tax benefits.  With an ESOP, you are selling stock in the company, not the assets, so the taxes are capital gains, not ordinary income taxes.  Because of this distinction, there are planning techniques available that may help save on taxes with this transaction.

 

Before implementing an ESOP, some important considerations are:

  • Most, if not all, of the excess cash flow from the business may be needed to repay the note, most , instead of using it to grow the company;
  • The company must set aside money to meet repurchase obligations on the ESOP when an employee retires, dies, becomes incapacitated or terminates his or her employment after vesting;
  • Stock in an ESOP is allocated based on payroll, so no extra management incentives can be provided.

 

Both management buyout and ESOPs are options that should be considered if you are looking to transfer your business to your employees.  An experienced business planning attorney can help discuss these options and find a solution that best protects you and your legacy.

Posted in Succession Planning

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