By Alison Lingane
Are you wanting to sell your business and retire? There are 2.3 million baby boomers—dubbed the Silver Tsunami—wanting to do the same. And with one-third of business owners over 50 reporting a hard time finding a buyer, your odds may not seem so great.
What if we told you there was a way to avoid needing to find and vet an outside buyer to take your company into the next generation? You could get control over the deal, set up the sale when you want, for the market value you deserve, while leaving a legacy you can be proud of? AND you could potentially tap into valuable tax benefits. It’s not too good to be true, but it takes careful planning, a team of experts and you’ve got to give your employees skin in the game.
Increasingly, business owners are discovering the ideal successor is right under their nose … their employees. With almost 20 percent of our private-sector workforce taking part in some way in the ownership of the company they work for, employee ownership is more widespread than you may be aware. Communities across the nation are investing in employee-owned models in an effort to keep these businesses and jobs locally based. Recently, with bipartisan support, Congress passed the Main Street Employee Ownership Act, a major breakthrough in support of employee ownership. This Act addresses the Silver Tsunami and expands access to financing these employee ownership exits through the Small Business Administration.
Employee Ownership Options
There are some great options for business owners wanting to explore a transition to employee ownership. The two most common forms of employee ownership include worker cooperatives and employee stock ownership plans (ESOPs). Both have been around for decades. The Perpetual Trust, or Employee Ownership Trust (EOT) is relatively new to the U.S. but has a solid track record in the UK.
Worker-owned cooperatives are 100 percent employee owned, and have democratic practices of one-member, one-vote, and majority employee-owner board representation. ESOPs are qualified retirement plans–like a 401(K)–and are used to transfer all or part of the company’s shares to a trust, administered on the employees’ behalf. EOTs offer a third option whose trust structure is similar to an ESOP. However, unlike an ESOP, which can be sold to private equity, EOTs guarantee that the trust owns the company in perpetuity, for the benefit of both current and future employees.
Some key differences between these employee ownership structures:
- Governance: Worker cooperatives are, by definition, democratically governed by worker-owners, while in the other two forms, employee governance can be designed in, but there is flexibility as to whether it is incorporated (for example, through a “Democratic ESOP,” which incorporates employee-owner governance).
- Profit-sharing: Worker cooperative and EOTs have built in profit sharing. An ESOP is a retirement benefit in the form of stock ownership that is redeemed at the point of retirement, so it does not have pay outs of profit built in to its structure. However, in a Democratic ESOP, profit-sharing, like governance and other voting rights, can be layered in.
- Tax Benefits and Regulation: All forms of employee ownership have tax benefits. ESOPs may offer the greatest tax benefits–both to the selling owner and to the company (if it becomes a 100 percent S-Corp ESOP). Federal laws govern many administrative aspects of ESOPs (they are regulated by the ERISA and the Department of Labor) which introduces significant set-up and ongoing costs for ESOPs that are far outweighed by the tax benefits, for companies above a certain small size.
Experts advise that companies with fewer than 20 employees may be too small for an ESOP, given the costs, although there can be exceptions. For larger companies, the tax benefits of an ESOP can be a major driver in the decision to transition to employee ownership. Worker cooperatives are appropriate for companies of all sizes and typically have much lower transaction and ongoing administration costs than the other models. EOTs offer more flexibility to design the trust structure than an ESOP does, and they guarantee that the business will be owned by employees for generations to come.
At Project Equity, we guide owners and employees through a process to assess the variety of proven models used to transition ownership to the employees. We help owners find the “right fit” solution, shepherd successful transitions, then support new employee owners in building a solid company with a highly engaged culture. As George Chittenden, owner of Adams and Chittenden Scientific Glass, one of our current clients, recently put it, “Hiring Project Equity as a third party brings objectivity to the table for the employees. The straightforward honesty with which they approach the work is credible and valuable. They help the employees understand that we are operating in good faith.”
The decision to sell your business to your employees is a highly personal one that often comes down to legacy. To help business owners make the decision about what exit path is right for them, we ask them to imagine themselves retired and looking back at their business five years into the future. This helps them filter their exit options through this lens of what really matters.
About Project Equity: Project Equity supports businesses to transition to broad-based employee ownership. We support selling business owners to assess fit with this approach, and to decide the options and structure that work best for their situation. We then work with the owner and a core group of employees to structure and successfully operationalize a transition to employee ownership and an effective ownership culture.
Alison Lingane, co-founder, Project Equity