For trusted business advisors such as certified public accountants, wealth managers, and financial planners, your clients’ success is evidence of the value you deliver.
You strive to guide clients to the strategies that best achieve their financial and legacy goals.
For business owners considering their ownership transition and eventual exit strategy, it’s hard to ignore the potentially immense tax advantages and ongoing business benefits that come with selling to an employee stock ownership plan (ESOP).
ESOPs provide unique benefits that can help business owners fulfill their goals, hopes, and dreams — in terms of their financial future, the legacy they’ll leave, and their commitment to their community. In fact, an ESOP is one of the most cash- and tax-efficient succession plans available to owners of closely held businesses.
From a business standpoint, an ESOP can actually become part of a long-term growth strategy.
The major liquidity event an ESOP transition triggers can create opportunities for trusted advisors to expand and deepen client relationships by offering services, expertise, and insights that may not have been needed before the ESOP sale.
To help you make the most of your client conversations, we’re highlighting seven key reasons they should explore an ESOP transaction as a tax-efficient liquidity event with the flexibility to meet their short-term and long-term wealth planning and business needs.
1. An ESOP Offers Clear Tax Advantages for C Corp and S Corp Companies
An ESOP purchase is paid for over time using the company’s pre-tax dollars. For many companies, ESOP contributions are tax deductible. And because S corporations that are 100% ESOP-owned are, in fact, owned by a qualified retirement plan, they are not subject to federal income tax. That increased cash flow can help fuel ongoing business growth.
If you’re considering an ESOP in the future, talk with an expert in advance about timing the plan’s establishment and potential tax advantages your company may be able to access — without impacting company cash flow.
2. Selling Owners Can Opt to Defer Capital Gains Tax
Another tax-advantaged option for selling shareholders of closely held C corporations is to elect a Section 1042 rollover. In this situation, a client who sells to an ESOP can indefinitely defer capital gains taxes on the sale of their shares.
This option may give selling owners time to plan strategies to help minimize their eventual tax liability. A Section 1042 exchange may be right for selling business owners who can invest sale proceeds in a qualifying replacement property (QRP) without creating personal liquidity.
If the business owner opts not to sell the QRP during their lifetime, a step-up in basis can eliminate capital gains taxes on the proceeds of the ESOP sale for estate beneficiaries. The help of a highly qualified tax professional is advised for business owners interested in this option.
3. ESOP Ownership Culture Fuels Employee Recruitment & Retention
In a recent study by the National Center for Employee Ownership, ESOP leaders reported voluntary quit rates that were about a third of the national average. In a talent market where “churn” is on the tip of everyone’s tongues, attracting and retaining talent is likely to become a top competitive advantage. And on the flip side of the same coin, employee-owners are reported to experience far fewer layoffs than the average U.S. employee.
Stability is as important for the wellbeing of the company as it is for employees, and keeping turnover under control is an important way for businesses to maintain their distinction as employers of choice.
4. Employee Ownership Aligns Employees’ & Company’s Financial Objectives
In an ESOP, workers share in the financial success of the company through their individual ESOP account balances. As company valuation rises, so does the value of the shares allocated to their accounts. While the study mentioned above points out employee retention value, there’s also the value of tying compensation to successful company performance. This can help many employees clearly see how their work impacts the bottom line — incentivizing choices that benefit the business.
That’s what ownership culture is all about. ESOPs reward employees by providing them with an ownership stake in the company they help build and strengthen. An ESOP allows the transfer of ownership to employees at no cost, and provides a means to employee ownership that doesn’t require employees to raise capital for a purchase.
5. ESOPs Enable Business Owners to Diversify Retirement Portfolios
Many owners of private, closely-held businesses have most—if not all—their wealth tied up in their companies. That can put them in a precarious position as retirement nears, if they think their only option is to sell to a third party in order to access liquidity. They may not be interested in making an exit. An ESOP sale separates the liquidity event from the owner’s exit, so they can use the cash proceeds of the sale to diversify their holdings well in advance of retirement.
This creates an important opportunity for a trusted advisor to deliver even greater value to the client:
As you work closely with them to update their investment portfolio and retirement plan. With a reduced or eliminated ownership stake post-transaction, it’s vital to discuss with clients how the ESOP sale can impact their financial security, tax position, and estate plans.
6. ESOPs Help Preserve Legacy and Uphold Community Relationships
For family-owned or founder-owned firms, an ESOP can play an essential role in carrying on the company’s legacy, even as it gradually transfers ownership to employees. While the ownership transitions to the ESOP trust, the company itself can preserve its core values and the relationships it has in its home community.
Even after the sale, the company remains locally owned, maintains and even grows the local community’s employment opportunities, and enables the company to honor long-standing commitments to local beneficiaries such as schools, nonprofits, customers, and vendor partners.
7. An ESOP Sale Guarantees Fair Market Value for the Business
An ESOP transaction is always a stock sale at full fair market value (FMV). By law, ESOPs cannot pay more than FMV to the selling owners, nor can the sale be negotiated for less than FMV. That means the selling owner will receive a fair price for their company, validated by an independent valuation professional. They won’t experience the pressure to accept anything less.
Help Clients Understand ESOPs’ Advantages & Comply With Their Requirements
It’s clear that an ESOP can provide unique business advantages—and it’s equally important to acknowledge that ESOPs also come with regulatory requirements that can be complex and call for professional guidance. If you’re a trusted advisor, you play a key role in ensuring your clients fully understand the advantages and obligations of an ESOP before they commit to the sale.
ESOPs also impact the employees who become beneficial owners of the company. Proactive change management communication and ESOP education are recommended to help employees understand the benefits and responsibilities that come with employee-ownership. Over the longer term, employees may also need diversification and retirement planning advice.
ESOP Sales May Lead to Additional Client Planning Needs
A major liquidity event like an ESOP sale can lead clients to engage with their trusted advisors for additional services such as insurance evaluations, wealth transfer and estate planning advice, strategies for philanthropic giving, and financial planning and management during retirement.
For CPAs, wealth managers, and financial planners, your client’s success is proof of the value you deliver. When an owner is ready to start talking about their exit, be sure to present comprehensive options that can serve their financial and legacy goals. As a trusted advisor, it's in your clients’ best interests to know all their options for selling a business. It’s equally crucial that you have the knowledge you need to help them make well-informed choices and continue to trust your guidance.
Take a closer look at the ways an ESOP sale compares with other common business exit strategies. Our free guide makes it easy. Just click below to get your copy today.