When transitioning their business to the next generation, selling business owners must sort through the multitude of available exit strategies. One strategy that is particularly attractive to many sellers is an Employee Stock Ownership Plan (ESOP). Not only are ESOPs a tax-advantaged transaction that may serve as a suitable exit strategy, but they allow the business owner to maintain some control and involvement in their business, if they choose. How can business owners determine whether an ESOP is a viable option, while weighing all available alternatives?
An ESOP feasibility study is a valuable tool that can provide clarity in the exit strategy decision – giving selling business owners confidence in both the future of the business and their own financial wellbeing. Though an ESOP feasibility study focuses on what an ESOP transaction would look like for the company, it also compares the ESOP with other strategies, providing the insight needed to narrow down the options and determine the best path forward.
The ESOP feasibility study helps to clarify not only if an ESOP is possible, but whether an ESOP is the right fit for all impacted parties – sellers, employees, managers and the Company as a whole. The study aims to answer not only whether an ESOP can be formed, but whether it should be formed.
Here are several ways ESOP feasibility studies can provide confidence and clarity throughout the exit strategy decision-making process.
Compare Alternatives
First and foremost, an ESOP feasibility study helps shareholders identify and compare alternatives. Though the study will primarily focus on ESOP feasibility and the circumstances surrounding ESOP formation and implementation, selling business owners can use what they learn in the study to compare the ESOP to alternative exit strategies, such as strategic buyer, private equity or management buyout.
The feasibility study allows selling shareholders to compare financing options and alternative structures of the transactions to see which option is the best for the Company and ESOP. Additionally, if it is decided that the ESOP is the right exit strategy for the company, company leaders must determine how the company will be incorporated going forward, as only corporate entities can sponsor the formation of an ESOP. The ESOP feasibility study includes information regarding the tax impact of organizing as a S-Corp or C-Corp to determine which is the best fit for the sellers and the company going forward.
Evaluate Financial Factors
An ESOP feasibility study utilizes various financial projections that indicate the ESOP’s likelihood of success and overall impact on the company. The indication of value, included within the study, is the most prominent financial analysis that is used to determine fair market value and selling price of the company. If the selling business owner concludes the sales price won’t meet financial objectives, they can determine the ESOP will not be a viable exit strategy and pursue other alternatives.
There are many other outcomes from the study; some of the key other outcomes are identified below.
- Structure of financing the transaction, including the use of company cash, seller financing and third party (senior lender) financing
- Analysis of the use of warrants in conjunction with the seller financing to achieve a desired internal rate of return (IRR) on the seller financing
- Analysis of use of stock appreciation rights (incentive compensation) for key members of management
- A projection of after-tax net proceeds to demonstrate the amount and timing of after-tax cash payments the selling shareholders may receive
- Future cash flow analysis to understand the impact the transaction will have on the go forward financial statements
- Projected annual stock price to understand the impact on warrants, stock appreciation rights (SARs) and participant account balances
Boulay Can Help
An ESOP feasibility study is the first step in determining if an ESOP is a viable exit strategy, which will allow the owners to save money in the long run by helping them decide whether to move forward with an ESOP or go in another direction. It helps sellers and company leaders get a full picture of the ESOP formation process, assess pros and cons, and ultimately choose the exit strategy that will help them achieve their objectives.
Because the exit strategy decision has a significant impact on the future of your business, it’s important for you to have a trusted and expert opinion on the matter. Allow us to help you make this important decision and provide you with the answers you need to accomplish your company’s goals. Boulay has been working with ESOPs since the 1970s and is a national leader in ESOPs through our involvement with the National Center for Employee Ownership (NCEO), the ESOP Association, and the Employee-Owned S Corporations of America (ESCA). Boulay works with over 125 ESOPs on an annual basis and has been involved in the formation of many of these ESOPs. Click here to contact Boulay’s ESOP leader, Dan Markowitz, today.