When you’re considering selling or transitioning ownership of your business, it’s important you assess your priorities, your ideal exit plan, and your business’s current financial state to determine which business succession option is best.
Many business owners who are looking to sell their business consider selling to an Employee Stock Ownership Plan (ESOP). In fact, six to eight percent of businesses will transfer to an ESOP, up from four percent in previous years. To help you determine which business succession option is the best fit for your business, I’ve outlined the most common options and the advantages and disadvantages of each. I have also included steps for moving forward with transitioning to an ESOP if you find it’s the best fit for you and your business.
Succession Option #1: Transition your business to a family member
For many business owners, passing on ownership to a family member or selling to their top managers is an obvious first option. It relieves the owner from their responsibilities while keeping the company in the family or in current leadership. However, throughout succession planning, some will find they lack family members who are interested, prepared, or equipped to handle taking on the business, and similarly, their chosen successor(s) within the company may not have the capital needed to acquire the business
Succession Option #2: Sell your business to a third party or to a private equity group
Once a business owner realizes transitioning ownership to family or selling to top leadership are not feasible options, they often consider selling to a private equity group.
Selling to a private equity group has advantages, including:
- It potentially allows the business owner to completely exit the company, allowing them to retire with no ownership responsibilities.
- The business owner can receive cash for the sale upfront.
- Some private equity groups are willing to pay above market value for businesses if they find it’s a good opportunity and fit.
A few things to keep in mind when considering selling to a private equity group include:
- Losing ownership responsibilities means you won’t have control over the future of the company, including its location, employee retention, and more. This means the sale could have a negative impact on the local community in which the business operates.
- The sale may require a large upfront tax payment. Consult your tax advisor for guidance on handling this factor.
Succession Option #3: Transition your business to an ESOP
While an ESOP may not be an obvious first thought for business owners engaging in succession planning, many find it meets their needs.
Selling to a private equity group could be more profitable upfront compared to transitioning to an ESOP; however, ESOPs come with many of their own advantages, including:
- Tax benefits for the seller, such as deferred or reduced capital gains taxes and income taxes.
- Minimized turmoil for the company and its employees. Selling to an ESOP allows the company to retain all of its employees, resulting in a smoother transition for employees and the business as a whole.
- More control over the business owner’s legacy. Especially for businesses in small communities, selling to an ESOP is a strategy founders may use to ensure employees are taken care of and their legacy remains intact even after they leave the company.
Ready to transition your business to an ESOP? Here’s what you’ll need
You’ll need a strong team in place to support your plan to transition your company to an ESOP. That team must include a good banker, an attorney and an accountant, all who understand the ins and outs of ESOPs and Employment Retirement Income Security Act (ERISA) law. You’ll also want a sell-side advisor to manage the process of negotiating, selling, and transitioning.