Family-owned businesses, a key pillar of the American economy, make up a significant number of the privately held companies across our country. Although these companies cut across all industries and range in size from small to large, they share common challenges. The most daunting of these challenges is how to manage the transition of the business from generation to generation.
Maintaining core family values in an ever-changing marketplace – often with diverging goals among the family members – is a challenge that many family businesses don’t survive. One intriguing solution to this challenge is to bring the employees into the shareholder group through the sale of stock to an employee stock ownership plan (ESOP).
The sale to an ESOP is a liquidity strategy for owners of privately held businesses, but it also provides desirable tax advantages to the owners who sell to an ESOP and to the companies that have an ESOP as a shareholder. A sale to an ESOP appeals to many family-owned businesses because of its flexibility, and because it can provide different options for different family (shareholder) groups. This can be of particular importance as family-owned businesses transition into the second, third and fourth generations.
ESOPs as a Solution
For family members who want to continue to own and run the business, the ESOP can provide significant tax advantages and support powerful gifting strategies to preserve the family ownership while minimizing personal, corporate and estate taxes. For family members who are not actively engaged in the business, the ESOP can provide a liquidity option or an income stream that supports life outside the family business. Oftentimes, divergent interests or goals cause family businesses to transition away from family ownership, but the ESOP can provide appealing solutions to preserve family ownership and control.
As family businesses grow, more positions within the company are assumed by non-family members. However, as these companies evolve, these same employees become members of the “family” and help perpetuate the culture and values of the original family business. An ESOP trust allows these members of the extended family (employees) to participate in ownership without the founding family having to cede control to an outside party.
Key characteristics of ESOPs make this possible:
- An ESOP can own a minority stake in the company.
- An ESOP trust, controlled by an ESOP Trustee, holds the stock on behalf of the employees; the employees don’t control the company.
- The board of directors continues to control the business, with senior management remaining in place.
- An ESOP trust is designed to have a long-term holding period, meaning there is no time limit to its ownership and it could own the company into perpetuity.
Selling all or a portion of the family-owned business to the employees through an ESOP is often a natural and comfortable transition, and it allows the culture of the company to remain intact while giving the family ultimate flexibility to meet the needs of all family members.
If you have comments or questions about this article, or would like more information on this subject matter, please contact us. Or visit our ESOP Planning Library to find additional resources to help guide you through the ESOP planning process.