Are ESOPs Really More Complex Than Other Ways to Sell a Business?
Using an ESOP for Business Transition Can Be Complicated, But Selling to an Outside Buyer Is Often Uncertain and Even More Complicated
When people describe the pros and cons of ESOPs, often they note that the plans are complex. ESOPs are somewhat more complex than 401(k) and similar retirement plans and do cost substantially more to install and somewhat more to operate, mostly because an annual appraisal is required for closely held companies. But ESOPs are not more complex than selling to a third party. The table below compares what issues come up in the sale of a company to an ESOP compared to a sale to a third party. It was prepared with the advice of professionals who have done both kinds of transactions. The table indicates that the overall level of complexity is similar, but ESOPs are much less risky in terms of the likelihood of finding a buyer. They are also considerably less costly, mostly because in the case of a sale to a third party, in addition to substantial legal, accounting, and sometimes other fees, the price paid to the seller is usually reduced by brokerage commissions paid by the buyer.
|ESOP||Sale to Another Company|
|Key legal documents||
|Feasibility studies and preparation||Feasibility studies assess whether the company has sufficient payroll and cash flow to buy the desired amount of stock. Can be performed internally or with expert advice. Forensic due diligence rarely needed.||Companies must prepare a detailed and accurate description of the firm and its finances, prospects, and risks. Buyers will want to do a forensic due diligence investigation and sellers should do the same to assess the financial soundness of the buyer and the terms of the offer.|
|Valuation||Outside appraisal required; valuation based on fair market value||In smaller deals, outside appraisal not required but recommended; in larger deals price usually set by controlled auction.|
|Terms and risks||Plans can be structured in a variety of ways:
|Buyers will typically have multiple contingencies:
|Time to sell||Once the seller has decided on doing an ESOP and its basic structure, four to six months.||Median formal offer to sale time is 10 months for companies in the small to mid-market range|
|Role of seller post-transaction||Flexible depending on seller interests||Buyer will usually determine role in smaller deals; in large deals role is usually negotiable.|
|Sale of minority interest||ESOPs can buy any percentage of stock from any number of sellers||Buyers almost invariably want to buy the entire company|
|Success rates||If an ESOP is determined to be feasible, only rarely do transactions fall through once a decision to proceed has been made||Overall, only about 25% of privately held businesses put up for sale are sold and only about 50% of businesses with 100 or more employees are sold.|