Big Picture - May 2018 - 19

typically be willing to lend funds to an individual or group of
individuals acquiring a stake in a lucrative business.
To assist your management team in the acquisition, you
may allow them to buy the stock over a period of time -
maybe three to five years. That will, of course, make the
purchase easier to manage because your team doesn't have
to come up with 100 percent of the funds all at once. At the
same time, this can put you at risk if you end up funding the
acquisition over time. If the business begins to struggle, then
your payment stream could be in jeopardy. To protect
themselves from this scenario, some owners stay involved in
the business until all the cash has been paid out (perhaps in
the capacity of a board member or in an advisory role).
There are various options for you to maintain some control
to mitigate your risk and help the process come to a
successful completion.
SELL STOCK TO YOUR EMPLOYEES

After evaluating the options of an MBO
versus an ESOP, my golfing buddy, er, I mean,
networking associate, chose the ESOP
approach for the succession of his business.
The opportunity to reward his employees for
their years of service and the comfort of
knowing that his business is in good hands
moving forward outweighed the challenges
and disadvantages.
Many scenarios of an ESOP buyout require the payments
to the exiting owner to be paid out in installments. This can
create some disadvantages to you as the seller. Because the
ESOP buyout is being funded by the operational success and
cash flow of the business, this can put additional cash flow
strains on the company. As such, there is an inherent risk to
the cash payouts from the business to the selling ownership.
The worst-case scenario is that the business fails and the
payments for the business buyout stop altogether; this risk
can be mitigated if the loan from the financial institutions to
the ESOP pays the majority or all of the purchase price up
front. However, this approach also can create a heavy cash
burden on the corporation. Ultimately, the best approach
with your ESOP buyout should be a balance of shared risk
among all parties.
One other disadvantage of the ESOP is that it's fairly
expensive to adopt and implement. Depending upon the
complexity and scope of your individualized plan, the cost of
putting the plan together and executing it will typically run
between $20,000 and $40,000 to the company. It's crucial to
weigh the advantages and disadvantages of both routes to
decide which buyout option is the best fit for your organization.
LEAVE YOUR COMPANY IN GOOD HANDS
After evaluating the options of an MBO vs. an ESOP, my
golfing buddy, er, I mean, networking associate, chose the
ESOP approach for the succession of his business. The
opportunity to reward his employees for their years of
service and the comfort of knowing that his business is in
good hands moving forward outweighed the challenges and
disadvantages. Use the information shared here, like my
friend did, to help you determine if an employee buyout is an
approach that can work for you when the time comes to plan
for your business succession.

BIGPICTURE.NET

The second method to sell your business to your employees
is through an employee stock option plan. The simple
definition of an ESOP is a qualified retirement plan that
allows employees to invest in stock in your business. ESOPs
provide a popular and effective way to reward your employees for their service and dedication, and allow them to
become owners in your company. Often ESOPs are implemented in programs that allocate merely a portion of the
stock to become available, with the current ownership still
maintaining the majority of the stock. The use of an ESOP to
sell your business is different. In this case, you'll use an
ESOP plan as a method to transfer the sale of your business,
or 100 percent of your company stock. This is typically
accomplished by having the ESOP borrow money from a
financial institution to finance the buyout of the shares. The
loan is secured by the assets and stock of the company and
is repaid by the company's cash flow.
Some of the advantages are the same as the MBO option.
Your current management team continues to run the
business, often with your involvement at some limited level.
Your employees are rewarded for their commitment to the
company and are now able to have a stake in the future
growth of the business. An ESOP also allows a much wider
range of employees to participate in purchasing shares of the
business. Under this succession method, business owners
have the added advantage of higher flexibility with the
timing of the succession and the level of involvement they
can have during the transitionary time. Many business
owners using ESOPs phase out their involvement over time,
as agreed upon in the ESOP plan documents. Because the
ESOP is funded from the cash flow of the business, a slower
phase-out period may make complete sense for both parties.
This could ensure continued success with the business while
simultaneously securing the deal through the profitability of
the company.
There are also some significant tax advantages with the
ESOP approach. If your company is an S corporation, future
business income is not taxed if an ESOP owns the company.
If your company is a C corporation, the proceeds from the
sale of your stock to the company's ESOP may be tax

deferred. Additionally, payments by the company to the
ESOP used to purchase the business owner's stock are tax
deductible. For a full understanding of the tax issues
associated with an ESOP, you will need to consult an
accounting professional.

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Table of Contents for the Digital Edition of Big Picture - May 2018