Employee Stock Ownership Plans (ESOPs) are gaining popularity across a variety of industries among business owners engaging in succession planning. The main benefits attracting business owners looking to sell include company sustainability, employee loyalty, and tax and other financial benefits.
While businesses in almost any industry may be eligible to transition to an ESOP, the top five industries I’m seeing make the move to ESOPs are construction/contracting, engineering, architecture, marketing/service and manufacturing. Here’s why.
Construction and Contracting
Out of the long list of benefits that come with transitioning to an ESOP, the benefit of getting a better company sale value is one of the most attractive to owners of construction and contracting companies. In many cases, when a construction or contracting business transitions their company, the sale value is based primarily on its assets (mainly equipment and real estate), a small value for market share, and the few months of work it already has lined up.
In contrast, when a construction or contracting business sells to an ESOP, their income and historical earnings are considered when determining its value. This number is generally much higher than assets, market share and work backlog combined. This high evaluation combined with the benefit of becoming a limited or non-tax-paying entity results in ESOPs being significantly more financially beneficial than many other succession options.
Engineering and Architecture
Engineering and architecture companies’ biggest assets are their people. Their business outputs, and even their other assets, such as machinery, are products of great engineers and employees. Therefore, employee shortages and high turnover can be extremely disruptive.
One benefit of ESOPs that engineering companies find attractive is that they lead to employee loyalty and retention and can even be used as a recruitment tool. Since employees have a beneficial ownership of the company, they have a stake in its performance. They become more motivated to do what’s best for the company and stick around to get a share of its success.
Marketing and Service
Both marketing and service firms have one thing in common: they don’t have many assets beyond the people they employ. This makes it challenging to get loans from traditional lending institutions like banks who often require collateral, such as significant real estate, vehicles, machinery and inventory.
Accounting and marketing firms – and similar types of industries – benefit from transitioning to an ESOP because then they can obtain financing based on historical earnings rather than just assets. They can then use the funds to continue growing their company and investing in their people.
Many manufacturing companies are located in smaller towns across the country and have a strong history in the communities they call home. When their owners are ready to take a step back, a common concern is how the employees and community will be impacted. Often when the company is purchased by a private equity group, the business may be relocated, renamed and its employees may be let go. Transitioning to an ESOP instead means the business can continue operating with the same people, in the same community and under the same name, and the owner can still take a step back. It’s a win-win situation for the business owner, community and employees.