Feature Article Employee Stock Ownership Plans by Shawn Ely, Managing Director; Lazear Capital Partners


usiness owners are always thinking about the future of their companies, but how often does that thinking include succession planning? More than half of small to mid-size private companies do not have a succession or exit strategy in place. Many believe that succession is merely turning over the Company to a family member or eventually finding a third- party buyer, but increasingly there is another popular option that is frequently overlooked or misunderstood – selling the Company to its employees.


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Selling to an Employee Stock Ownership Plan Employee Stock Ownership Plans (ESOPs) can be an ideal and flexible exit strategy option for business owners. Depending on how the plan is structured, an ESOP can provide a variety of benefits that accrue to all stakeholders:


• The owner can sell from 0% to 100% and receive a full and fair market value for the Company


• The owner can elect to sell tax- deferred/tax free


• The Company can operate tax-free going forward


• The history, culture and legacy of the family and Company are preserved


• Employees are given ownership in the Company over time – without investing a dime


• Existing Sellers/Management can


continue to run and control the operations of the Company


• Key employees can realize significant economic benefits via Stock Appreciation Rights (SARs) and their participation in the ESOP itself


What is an ESOP? An ESOP is a qualified retirement plan for the benefit of the Company’s


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employees. Rather than holding mutual funds, as is common in a 401(k) Plan, an ESOP primarily invests in the employer’s stock. The ESOP rules are set forth in the Internal Revenue Code, and they provide two significant tax benefits:


• The owner may sell his/her shares to an ESOP and either defer or eliminate the capital gain tax on the sale, thereby increasing the seller’s net proceeds by approximately one-third when compared to any other type of sale. For instance, if an owner could sell the Company for $20 million to a competitor, he or she would net approximately $15 million after capital gains taxes. With a sale to an ESOP, the owner could net the full $20 million, or a $5 million increase.


• Since an ESOP is a retirement plan, all of the Company’s post-ESOP earnings may be federal and state income tax-free, significantly increasing the Company’s cash flow. For instance, a Company with $3 million in taxable income would pay about 33% in federal and state income tax, or $1 million. With an ESOP, the income tax can be $0, for a savings of $1 million per year.


There are also personal benefits


when selling a company to its employees. ESOPs are an especially attractive option for business owners who want their business to remain intact beyond succession while also rewarding loyal employees. For example, Kovatch Castings, Inc. (“KCI”), is an Investment Castings business in the Akron/Canton, Ohio area. In late 2019, Doug Kovatch, the 100% owner and the son of the founder, announced that he was transitioning the Company to Employee Ownership. KCI had grown from $4mm of revenues and 40 employees in 1991 to over 200 employees and $25mm of


revenues as a leading participant in the Investment Castings industry.


Doug’s


employees had been instrumental in helping grow the Company over the years while also cultivating a culture of safety, quality and support for the community.


As Doug noted, “I had


looked into the possibility of third-party sale, but one of my board of advisers suggested I consider an (Employee Stock Ownership Plan). The more I learned about it, the more an ESOP became sort of the clearest strategy to meet my goals.” For KCI and Doug, the ESOP not only


fulfilled personal financial goals, but it secured existing employees’ roles while providing them with an opportunity to participate in the future success of the business. “It allowed me to keep in place my managers, who share my vision for our future, keep the Kovatch name and hopefully have it continue for many more generations to come.”


Structuring an ESOP Any time you sell your business, there is no guarantee of the outcome. You can, however, follow some guidelines to sset yourself and your company up for success in developing and establishing a solid structure. An ESOP can be incredibly flexible and structured to best meet the needs of the selling shareholders as well as current and future employees. The complexity of a sale to an ESOP


can vary by factors such as the number of owners or entities involved in the Company, the availability of reliable financial information, and the ultimate goals of the selling shareholders.


Is an ESOP a Good Choice for me? It is essential to assemble the right team of advisors from the beginning who will help you choose the best path to achieve your personal and financial goals. Selling to an ESOP involves a number


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