Passing a family business down from generation to generation is not always possible. However, most small business owners want to ensure that the firm and culture they have developed over time is preserved well into the future regardless of family involvement. An Employee Stock Ownership Plan (ESOP) is a great way to maintain some control over a family-owned business as ownership is ultimately distributed to company employees. Although its primary purpose is to provide a market for the shares of a departing owner of a closely-held business, an ESOP can provide many distinct advantages:
Whether the sole owner of a business or a partial owner with family, succession planning is a critical component in ensuring the long-term success of a business. An ESOP can be a viable option for private, family businesses that lack outside buyers or next-generation family members to take over. In this scenario, businesses can make tax-deductible cash contributions to the ESOP to purchase the departing owner’s shares, or the ESOP can borrow money to buy the shares. Since cash contributions are tax-deductible this can be an attractive strategy for owners to sell their shares.
Another interesting feature of an ESOP as an employee benefit plan is its ability to borrow money on a tax-advantaged basis to fund itself. If an owner chooses to not make cash contributions outright, the ESOP gives the chance to borrow cash to buy company shares. Unlike debt repayments, when the business repays the loan, both principal and interest payments are tax-deductible.
An ESOP can be beneficial to both employees and owners simultaneously: in addition to tax benefits for the business, the employee contributions are tax-free, and distributions are taxed at favorable rates. An employee’s ESOP account distributions can be rolled over to an individual retirement account to defer capital gain taxes.
While ESOPs offer some very interesting benefits to the owners and employees of family-owned or closely-held businesses, they do have some limitations as they cannot be used in business structures and their set up and maintenance can be costly. This is where the proper research and consultation from a firm like Duncan Williams Asset Management, LLC can make finding the best way to manage succession planning and transition ownership of your business easy.