Posts made in May 2015

An ESOP could be an alternative exit strategy for business owners

The Denver Post


Posted:   05/24/2015 12:01:00 AM MDT

An ESOP could be an alternative exit strategy for business owners

PROOF IMAGE - SDR Ventures executive headshot session Feb. 7, 2015. (copyright Mark T. Osler. ALL RIGHTS RESERVED.

By Gary Miller GEM Strategy Management, Inc.

As business owners approach retirement age, many consider selling and often face difficult decisions related to the value of their enterprises.

While a business owner wants to receive fair-market value for the business, he or she may not want to sell to a third party. The owner may want to reward loyal employees who have made significant contributions to the success of the business, and for these owners, an employee stock ownership plan, or ESOP, may be a practical exit strategy.

What is an ESOP? It is a type of qualified retirement plan similar to a profit-sharing plan with one main difference. An ESOP is required by statute to invest primarily in shares of stock of the ESOP sponsor (the corporation selling the stock). Unlike other qualified retirement plans, ESOPs are specifically permitted to finance the purchase of employer stock by borrowing from the corporation, other lending sources or from the shareholders selling their stock.

When Congress authorized ESOPs in 1957 and defined their rules in 1974, it had two primary goals: to provide tax incentives as a vehicle for owners of privately held companies to sell;  and to provide ownership opportunities and retirement assets for working-class Americans.

How does an ESOP work? The corporation’s board of directors adopts an ESOP plan and trust and appoints an independent ESOP trustee. An appraisal of the corporation’s equity is obtained. The trustee negotiates the purchase of all or a portion of the corporation’s issued and outstanding stock from one or more selling shareholders.

The corporation may borrow funds for a portion of the shares from an outside lender and loan the proceeds to the ESOP so the ESOP can purchase the shares. (Rarely does the corporation have enough cash on its balance sheet to loan to the ESOP; hence the corporation typically will borrow from an outside lender.)

The corporation is required to make tax-deductible contributions to the ESOP each year, similar to contributions to a profit-sharing plan. The trustee uses the funds to repay the outstanding loans. In addition to the mandatory contributions, the corporation can declare and issue tax-deductible dividends or earnings distributions on shares of the corporation’s stock held by the ESOP. Often the trustee will use these dividends/distributions, too, to pay down the ESOP’s loans.

Tax benefits of an ESOP exit strategy accrue to the selling shareholders, the corporation and the employees who participate in the ESOP. The tax benefits to the selling shareholder and corporation are significant.

Nontax advantages of an ESOP exit strategy are many and should be considered by the business owner depending on the owner’s goals. Some of the advantages:

  • A ready-made market for the owner’s stock or business.
  • A business owner can gradually transition the ownership over a period of time and thus remain actively involved in the business.
  • A vehicle for the owner to receive the desired liquidity without selling to a competitor.
  • A retirement benefit for employees.
  • Avoidance of integration plans and associated costs to restructure operations, reorganize management or reduce staff because management and staff continue in place after the transaction closes.
  • Avoidance of giving out confidential information to a competitor or other potential buyers.
  • A long-term financial investor — the ESOP — that will not seek to sell the corporation in a relatively short time period.

Like most business decisions, there are trade-offs to any exit strategy. An ESOP is no different.

It is important to remember that an ESOP is a qualified retirement plan governed not only by the Internal Revenue Code, but also by the fiduciary and disclosure rules of the federal Employee Retirement Income Security Act.

The cost of meeting these fiduciary duty standards can be high, including hiring financial and legal advisers to the ESOP trustee and the seller, as well as additional expenses related to ongoing administrative management.

ESOPs are highly technical and complex. If business owners are considering an ESOP as an exit strategy, careful planning and consideration among professional advisers, including a wealth management firm, a qualified ESOP tax adviser and a qualified ESOP transaction law firm are musts.

Gary Miller is managing director of Denver-based SDR Ventures’ consulting division. SDR is an investment banking firm that advises privately held middle-market businesses. Miller specializes in strategic business planning, and merger and acquisition and exit-strategy consulting. He can be reached at 970.390.4441 or 

Cost of selling could be substantial



Gary Miller

Many owners plan to sell their businesses someday. Often, they think about their retirement and dream about their lifestyles based on the money they will make from the sale. But, more often than not, they have not anticipated the costs involved or the time it takes. This is not surprising, since most owners have concentrated on building their businesses rather than selling them. I find most owners, at first blush, are shocked at the costs incurred and the time necessary to prepare a business for sale. Negotiations with potential buyers take time and the legal, accounting and consulting fees needed to complete the transaction cost money. Often it takes from six months to two years to prepare a business for sale and another two years to sell a business. Once owners grasp the scope of work and associated costs, many try to avoid outside transaction experts to save money. They use their business accountants and corporate attorneys either having no, or very limited, “transaction” experience.

Research indicates owners who use an experienced transaction deal-team often realize higher multiples, better terms and conditions and sell their businesses more quickly than owners who do not. This is a result of being better prepared and having your company in pristine condition before going to market. For example, if an industry’s selling price multiples range from 4 to 8 times EBITDA (earnings before interest, taxes, depreciation and amortization) and the average is 5.2, it will sell at the higher range of those multiples if it is well prepared. Companies that are minimally prepared will sell at the lower range of the multiples — if they sell at all.

Below, are some general guidelines and cost ranges to consider if you are selling your business in the next five years. The guidelines vary significantly depending on the size and complexity of the company.

If you are an established business, there are three stages to go through in selling your business: 1) Preparation to go to market; 2) Identification of potential qualified buyers leading to a Letter of Interest and, 3) Due, diligence, negotiations, purchase and sale agreement and closing documents. Prepare to incur costs for each stage.

The most important decision a business owner makes is the selection of his “deal team”. The most important criterion for selection is transaction experience.

The first member of the deal team is a transaction consultant who specializes in mergers and acquisitions. The consulting firm’s first job is to address preparing the firm for market and leading the other deal team firms throughout the transaction process. The cost of the consulting firm can range between $100,000 to $350,000, or more, plus expenses, depending on the size and condition of the company, time it takes to sell the company and company complexities.

The second deal team member is the transaction wealth management firm who can guide you in wealth preservation and tax avoidance or deferral (not tax evasion).

The final three deal team firms are the transaction law firm, the transaction accounting firm and the investment banking firm, all of whom can work together with the wealth management firm to negotiate the best deal structure, price and terms while at the same time minimizing your tax liabilities.

Costs for a strong transaction law firm team can range from $75,000 to$350,000 or higher, plus expenses, depending on time and complexity of the transaction.

Costs for the accounting firm can range from $50,000 to $400,000 or more, plus expenses, if they have to audit your last three years of financial statements.

Costs for an investment banking firm include an up-front retainer fee ranging from $60,000 to $300,000 or more, plus expenses and a “success fee” for completing the transaction. Success fees range from 3.5% to 10% based on the size of the total transaction value of the sale. While much of the above may sound complex and expensive, business owners who use experienced transaction teams more often than not win more than they lose.

Gary Miller is founder and CEO of GEM Strategy Management Inc., a national firm focusing on strategic planning, raising growth capital, M&A, planning exit strategies, preparing companies for sale and post-integration processes for middle-market companies. Reach him at gmiller@ or 970.390.4441