Month: October 2023

As business owners approach the inevitable crossroads of exiting their companies, they are faced with a multitude of options. One compelling strategy that has gained popularity in recent years is the Employee Stock Ownership Plan (ESOP). ESOPs offer a unique path for business owners to transition out of their companies while providing employees with a stake in the business’s success.

In this blog, and in the spirit of Employee Ownership Month this October, we will explore how ESOPs work, the benefits and challenges they present to business owners, and how advisors should present ESOPs as an Exit Planning solution.

How ESOPs Work

An Employee Stock Ownership Plan (ESOP) is a qualified retirement plan that effectively allows employees to become partial owners of the company. Here’s a simplified overview of how ESOPs typically work:

• Establishing the ESOP: After careful planning, a company establishes an ESOP trust, which holds shares of the company’s stock on behalf of employees. To fund the plan, shareholders either sell stock, contribute shares directly, or the company will contribute cash (which can be used to purchase shares) 
• Employee Participation: Most full-time eligible employees participate in the ESOP. Certain exclusions can be made for union members and similar defined classes. Over time, employees accrue shares in the plan. They do not pay out-of-pocket for these allocations.
• Valuation: An independent appraiser determines the value of the company’s shares annually. This valuation process ensures that employees’ ESOP accounts reflect the fair market value of the shares they own.
• Employee Benefit: Share allocations vest over time, like a 410(k).  Upon retirement or separation from the company, a participant’s vested shares are sold back to the company at a current valuation. They can pocket those gains or roll the proceeds into another qualified retirement plan.

Here’s more detailed information on how an ESOP works.

Benefits of ESOPs for Business Owners

• Ownership Transition: ESOPs can provide an orderly and gradual transition of ownership, allowing business owners to step back while retaining equity and/or a leadership role with the company. Post-transaction, an employee-owned company’s board of directors maintains operational control. Companies remain independent.
• Tax Advantages: ESOP transactions can offer tax benefits to both the selling shareholder and the company itself. In many cases, a shareholder’s capital gains from selling equity to the ESOP can be deferred and potentially eliminated altogether. Companies can receive income tax deductions for contributions and can even become tax-free entities.
• Employee Engagement & Incentives: ESOPs can boost employee morale and productivity, as employees have a financial stake in the company’s success. This can lead to improved company performance and profitability. When employees gain a unique retirement benefit in the form of stock allocations, the employee-owned company as a whole tends to outperform their peers.
• Preservation of Legacy: Business owners who have poured their heart and soul into their company can use an ESOP to preserve their legacy and ensure the company’s continuation.
• Upside & Flexibility: Unlike most business transitions, ESOPs offer continuity of leadership and opportunities for shareholders to sell partial holders and get a second “bite at the apple.” An employee-owned company can also be sold to a third-party. Additionally, when ESOPs prosper, that upside is available to all stakeholders.

To learn more about upside potential and flexibility in ESOPs, watch the recent webinar recording hosted by David Blauzvern of CSG Partners.

Challenges of ESOPs for Business Owners

• Complexity: Like an M&A transaction, ESOPs have unique intricacies. Business owners should fully appreciate the ESOP process, and will likely rely heavily on expert advice and professional guidance.
• Structured Transaction: Plan formations and ongoing management are regulated by the US Department of Labor, based on rules set by the IRS. As a result, a regimented transaction process and diligent plan oversight are necessary.
• Initial Cost: The expense of forming an ESOP can be on par with an M&A transaction. Legal, valuation, and trustee fees all contribute to the overall cost.
• Sale Price: A trustee cannot offer more than fair market value for company stock. That’s typically in line with what a financial buyer could pay. This might be seen as a negative to owners who believe they can get more by selling outright to a strategic buyer.
• Ongoing Commitment & Maintenance: If business owners don’t already have a strong management team in place, their continued engagement with the company may be necessary post-transaction. Further, since an ESOP is a ERISA-authorized qualified retirement plan, trustee oversight of plans and annual company valuations are required.

Presenting ESOPs as an Exit Planning Solution

For professional advisors and business consultants, effectively presenting ESOPs as an Exit Planning solution requires a thorough understanding of the client’s goals and business dynamics. Here are some key steps to consider:

1. Assessment: Begin by assessing the client’s business, financial situation, and long-term objectives. Determine whether an ESOP aligns with their ultimate goals.
2. Education: Educate the client about ESOPs, explaining how they work, their benefits, and potential challenges. Provide case studies and examples to illustrate real-world applications.
3. Valuation: Help the client understand the valuation process and how it impacts the ESOP transaction. Highlight the potential tax advantages of selling to an ESOP.
4. Implementation: Map out a formal ESOP process with the client. Steps may include determining feasibility, selecting an optimal structure, securing third-party financing, engaging an independent trustee, establishing an the employee trust, negotiating a transaction, and finalizing plan documents. ESOP specialists may be needed for some, if not all these steps. With that in mind, assist the client in the selection of third-party professionals.
5. Employee Communication: Assist with the plan rollout process and encourage ongoing communication with employees to ensure they understand the ESOP’s benefits and their role in the plan’s success.
6. Long-Term Strategy: If the transaction does not represent a complete business exit for your client, work with them to develop a long-term strategy for the business post-ESOP, addressing their continued involvement and ultimately, their transition out.

How BEI ESOP Partners Can Help: CSG Partners

At BEI, we want advisors to be able to leverage your expertise, tools and industry partnerships to help their business owners thrive. Knowing that advisors appreciate the value of an extensive Exit Planning toolkit, we urge advisors interested in ESOPs as a planning solution to connect with our partners, including CSG Partners.

BEI supports CSG and their work in the ESOP market because they have guided hundreds of companies nationwide through the employee ownership process – from feasibility studies to financing and completed transactions. CSG Partners focuses on education geared towards advisors like you to help you honor and strengthen both your client-advisor relationship and your client’s perception of their Exit Planning experience.

If you are an advisor looking to adopt ESOPs to your toolkit, get connected with CSG Partners in a variety of ways:

• Listen to a recent presentation by CSG Partners Vice President, David Blauzvern, titled, “ESOPs: When Flexibility and Upside Matter Most,” linked HERE.
• Tune in for a short interview of David Blauzvern on BEI’s Why We Plan podcast.
• Schedule a meeting directly with CSG HERE.

Conclusion

Employee stock ownership plans (ESOPs) offer a compelling Exit Planning solution for business owners looking to transition out of their companies while preserving their legacy and providing employees with a stake in the company’s success. By understanding how ESOPs work, recognizing their benefits and challenges, and presenting them effectively to clients, advisors can help business owners make informed decisions about their exit strategy, ultimately contributing to successful transitions and continued business prosperity.

Author:  Kelly Finnell, President of Executive Financial Services, Inc.

When business owners consider selling their company, they often fall into one of two distinct categories. There are those who seek to maximize the sales price and receive as much cash upfront as possible, driven primarily by financial gain. And then, there are those who aspire to a more comprehensive vision. Beyond the desire for a good selling price, these business owners aim for a transaction that not only rewards them but also safeguards their employees and preserves the cherished company culture. These individuals can be aptly described as Compassionate Capitalists.

Capitalism and Compassion: An Age-Old Debate

The debate surrounding Capitalism and its relationship with greed has persisted since the very inception of the economic system. Philosophers, historical figures, and ordinary people alike have all weighed in on whether Capitalism inherently relies on unchecked self-interest, or if it can coexist with compassion and societal responsibility. Some argue that Capitalism thrives on self-interest, while others contend that it can function harmoniously with compassion, benefiting not just business owners but society as a whole.

Historical Perspectives on Capitalism

To delve deeper into this debate, let’s examine the views of two iconic figures from history: Karl Marx and Andrew Carnegie. Marx, a 19th-century German philosopher and economist, viewed Capitalism as inherently exploitative. He believed it created social and economic inequalities, with Capitalists profiting from the labor of workers who received less than the value of their contributions. Marx advocated for wealth redistribution and worker ownership of production means to address these issues.

In contrast, Andrew Carnegie, a Scottish-American industrialist and philanthropist, believed Capitalism could be a force for good. He argued that the accumulation of wealth was a natural part of the economic system but emphasized that wealthy individuals had a moral obligation to use their riches for the betterment of society. Carnegie donated millions of dollars to support causes such as education and public libraries, viewing philanthropy as a means to address inequality and poverty within the existing economic system.

Employee Stock Ownership Plans (ESOPs): Bridging the Gap

The emergence of Employee Stock Ownership Plans (ESOPs) in the mid-20th century represents a practical manifestation of both Marx and Carnegie’s ideals. ESOPs empower workers through ownership while operating within the framework of Capitalism. Developed by Louis Kelso, ESOPs aimed to align the interests of employees and owners, enhancing motivation, productivity, and shared success.

The History of ESOPs

ESOPs trace their roots to the mid-20th century when the concept of employee ownership gained traction as a response to labor challenges and changing economic landscapes. In the 1950s, economist and lawyer Louis Kelso developed the framework for ESOPs, believing that employee ownership would lead to increased motivation, productivity, and commitment to a company’s success.

The Employee Retirement Income Security Act (ERISA) in 1974 provided legislative support for ESOPs, establishing guidelines for their administration, funding, and fiduciary responsibilities. Subsequent amendments to the tax code enhanced the tax advantages of ESOPs, making them more attractive to business owners seeking socially responsible ownership transitions.

The Benefits of ESOPs

ESOPs offer compelling advantages for both business owners and employees. Owners can defer or eliminate capital gains taxes when selling shares to the ESOP, making it an attractive exit strategy. Employees, on the other hand, gain an ownership stake in the company and benefit from tax-deductible contributions made by the company to the ESOP. As the ESOP allocates shares over time, employees enjoy the appreciation of those shares, enhancing their financial well-being and sense of ownership.

Furthermore, ESOPs motivate employees by giving them a genuine stake in the company’s success. The sense of ownership fosters higher engagement, increased morale, and a broader range of workplace benefits. This model aligns the interests of workers with those of management, creating a more collaborative and equitable workplace.

A Compassionate Capitalist Case Study

A real-world example illustrates the power of Compassionate Capitalism through ESOPs. In 2011, a defense contractor with 1200 employees, considering an ESOP transaction, transitioned to an employee-owned model. Over the next decade, it experienced significant growth, and in 2020, it sold for $1.6 billion. This resulted in hundreds of millionaires among the ESOP participants.

One poignant story from this transition involved a long-tenured mailroom employee who, after the sale, learned he would receive over $4 million from his ESOP account. Overjoyed, he planned to use this windfall to establish a fund to pay for his grandchildren and great-grandchildren’s college tuition.

Want to learn more from the firm who carried out this transaction? Click HERE to register for an upcoming webinar with our partners at Executive Financial Services, Inc.! 

The Essence of Compassionate Capitalism

In the ESOP model, business owners do not need to sacrifice a fair purchase price to protect their employees, preserve company culture, and create generational wealth opportunities. Compassionate Capitalism, as exemplified by ESOPs, demonstrates that Capitalism and compassion can coexist harmoniously. It’s about centering employees, nurturing a thriving company culture, and providing opportunities for financial prosperity while still achieving a fair market value for the business.

In the words of Andrew Carnegie, “The man who dies thus rich dies disgraced.” Through Compassionate Capitalism and ESOPs, business owners can realize their vision of wealth and success while uplifting their employees and contributing to a more equitable and sustainable economy for all. As we reflect on the age-old debate between Capitalism and compassion, ESOPs provide a compelling answer that bridges the divide and propels us towards a more compassionate and prosperous future.

Join us for an upcoming webinar with guests from our trusted partners at Executive Financial Services, “ESOPs: How Successful Advisors Participate and Benefit,” where you’ll gain valuable insights into the world of ESOPs and discover how to leverage them to benefit your clients and your own practice. 

Exit Planning is a critical component of financial advisory services, helping business owners prepare for the successful transition of their businesses. However, despite its importance for owners, many advisors face several pain points and challenges when introduced to the concept of Exit Planning and the idea of adding it as a service to their professional practice. In this blog post, we’ll explore the various hurdles and obstacles that advisors encounter when considering Exit Planning and how these can be overcome to ensure success in this vital area.

Advisor Pain Points & Solutions

• Limited Budget Availability

One of the primary challenges advisors face when looking to incorporate Exit Planning into their practice is the perception that it requires a substantial budget. The cost associated with training and planning tools can deter advisors from taking the first step.

Solution: Contrary to popular belief, effective Exit Planning doesn’t always require a massive financial commitment. Advisors can start small and gradually invest as their practice grows. We’re confident you will see the long term benefits of offering Exit Planning as a service, even with a foundational level of Exit Planning knowledge. 

• Compliance Approval

Advisors often encounter hurdles in obtaining compliance approval to offer Exit Planning services or use the associated tools and content. Regulatory constraints can slow down the process and create frustration.

Solution: Collaborate with service providers of these solutions to streamline the approval process. Ensuring that all materials and processes meet regulatory standards makes it easier for advisors to obtain the necessary approvals. The BEI Team has worked with several compliance departments to get solutions approved for advisors. 

• Lack of Bandwidth

Many advisors have limited bandwidth due to their existing client commitments and workload. Adding Exit Planning services can seem overwhelming.

Solution:  Integrating Exit Planning into your  practice can be a gradual process. Delegate tasks when possible and make use of tools and resources that can simplify the process. With the right tools in place, you can clear up some of the bandwidth challenges through streamlined communication among team members, project timelines and deadlines, and automated systems for data entry and report creation. 

• Certification Misconceptions

Some advisors believe they must be certified in Exit Planning before offering it as a service. This misconception can be a significant barrier to entry.

Solution: Certification is not always a prerequisite. While certifications such as BEI’s Certified Exit Planner Designation (CExP) can enhance credibility, advisors can begin offering Exit Planning services with the right training and tools. Further, as in the case with the three-step training program that leads up to the CExP designation, advisors can begin practicing Exit Planning while they are working through training. You do not need to be an expert in all aspects of Exit Planning in order to start offering services to clients. You simply need to have an understanding of what an owner’s goals are today and what team members are needed to get them there. 

• Perception of Complexity

Exit Planning is often perceived as a complex and daunting field, deterring advisors from diving in. It’s seemingly much more logical and comfortable for you to “stay in your lane.” 

Solution: As many BEI Advisors can attest, after just a few client engagements, business owners and advisors alike are often able to demystify Exit Planning. With BEI’s tools and resources designed for this very hurdle, you can break down the process into manageable steps and receive ongoing support to address any complexities that may arise. Many advisors find success in looking inward to see if there is a specific niche market or industry they can focus on that will set them apart from their competitors. Every business is different, but every business owner will need an exit strategy, regardless of industry or audience. 

• Already Successful

Advisors who are already successful in their line of work may hesitate to add Exit Planning to their practice, thinking they don’t need it.

Solution: Consider the added value that a business owner receives when your core services are coupled with Exit Planning services that they may not even know they need. Likewise, offering this service positions you as your client’s most trusted advisor, ultimately deepening client relationships and opening doors to new opportunities and success. 

• Time Constraints

Advisors often cite time constraints as a reason for not engaging in Exit Planning. They may feel too busy or think it’s the wrong time of year.

Solution: A good tip to consider, when adding any additional responsibility, is to revisit how your time is spent. Many BEI Advisors schedule dedicated time for Exit Planning and have a separate strategy of communicating its importance to clients. That’s why with a BEI Growth License, you’re given access to hundreds of content pieces, plus newsletter automation to easily allow for incorporation into existing processes without overwhelming your schedules.

• Uncertainty About Fees

Advisors may be unsure about how to charge fees for Exit Planning services, which can deter them from getting started.

Solution: Charging fees and determining fees structures vary across the board. There is no harm in testing a few methods to see which strategy works best for both you and your clients. Regardless of pricing structures, adding Exit Planning allows for the additional and recurring revenue that you may not otherwise receive if not providing the long-term, comprehensive planning that is Exit Planning.   

• Staying Active with Tools and Resources

Advisors who join Exit Planning programs like BEI may struggle to stay active and engaged with the provided tools and resources.

Solution: BEI provides ongoing training, webinars, conferences, and various means of support to keep advisors motivated and informed. It is an emphasis at BEI to provide advisors with opportunities for continuous learning and improvement. Additionally, it’s our goal to continuously enhance and update the planning software to improve ease of use and capabilities.  

Hurdles in the Learning Process

Advisors may find it challenging to learn a new approach and framework for Exit Planning.

Solution: BEI has been working tirelessly to develop user-friendly software and resources that simplify the planning process. With a BEI Planning or Premium License, there are videos and articles that offer tips to help advisors like you quickly grasp the essentials. In the event that you find yourself needing more support on how to engage a client and build a plan, BEI can put you in contact with a planning consultant to guide you through each step to ensure success.

Combination of Services

Advisors often seek a combination of services, including tools and resources, to complement their Exit Planning efforts.

Solution: Collaborate with complementary services offered by our industry partners to provide a comprehensive suite of tools and resources that address various aspects of Exit Planning. 

Conclusion

While advisors may face numerous challenges when considering Exit Planning, these obstacles can be overcome with the right strategies, support, and resources. By addressing budget concerns, simplifying the process, and emphasizing the benefits, advisors can successfully add Exit Planning to their practice and provide valuable services to business owners seeking to transition their businesses effectively.

Ready to learn more? Schedule a meeting with us so we can walk you through some of the most common pain points and disprove some common misconceptions so you can be on your way to the next level.