Why ESOPs Are Becoming a Popular Method of Succession Planning

An increasingly popular method of transferring business ownership is via an Employee Stock Ownership Plan, or ESOP. Though insider transfers and sales to third parties still reign supreme, 6% of surveyed business owners have interest in ESOPs at some level. I’ve written about the basics behind ESOPs before, including a general overview of how they’re set up , but one thing is clear. ESOPs are often perceived as prohibitively complex, and if they’re implemented incorrectly, they can devastate an owner’s Exit Plan.

Given the complexity of ESOPs and the risk involved when they’re implemented incorrectly, why do a noticeable percentage of business owners consider them, even when they know about the complexity and risk involved?

Recently, a colleague of ours—Kelly Finnell of Executive Financial Services —moderated a discussion panel whose topic centered on ESOPs. During this discussion, Kelly and his colleagues laid out the basic structure of an ESOP transaction and some of the more common elements that ESOP professionals use to overcome key issues. While the technical aspects of ESOPs are infinitely useful, the most revealing part of the panel was the simplified discussions about how ESOPs can provide unique protections to business owners.

Panelists explained that ESOPs are often misunderstood as disadvantageous to key employees, primarily because most people think that key employees see no tangible benefit from an ESOP. However, the panelists explained that an important part of ESOP creation includes strategies that keep key employees focused and motivated to stay with and grow the company by rewarding them for good performances. This creates a dual advantage: For key employees, it rewards them for staying with and growing the company as the owners prepare to leave. For owners, it builds their companies’ transferable value , which makes it easier for them to exit on their terms.

The panelists also noted that with the right measures and conditions, properly crafted and implemented ESOPs give business owners flexibility in terms of their Exit Planning timeline. Specifically, there are ways for business owners to begin selling their stock to an ESOP today and still benefit from the company’s future success. This flexibility is appealing to owners, especially owners who aren’t sure which Exit Path they’d even consider or have some flexibility in their departure timelines.

Finally, the panelists pointed out that some of their ESOP clients prefer ESOPs because and ESOP is a "qualified retirement plan," which means that it's overseen and regulated by the government in ways that less formal plans aren't. They like that ESOPs are subject to government oversight and supervision because that gives their management teams and employees a bit more assurance that they’re protected to the extent possible. To many business owners, protecting their employees is paramount , which makes ESOPs a useful option.

The common threads that run through these discussions are simplicity and security. When misunderstandings about a topic are prevalent, it’s up to the experts to boil the topic down into its simplest possible form. When business owners understand that ESOPs are complex but that they have access to advisors who can help them understand what ESOPs do in terms of Exit Planning, it opens new avenues for success and discussion.

Related: 3 Ways Succession Planning Relieves Stress for Business Owners

Advisors who distill the complexity of ESOPs—or of any complex topic in general—to something that business owners care about and understand give themselves an advantage. And advisors who cannot distill the complexity of ESOPs can still position themselves to succeed with their business-owning clients by finding advisors who can explain it for them as a trusted member of their Advisor Teams .

On its face, an ESOP can be complex. This complexity can cause business owners and advisors alike to throw up their hands in defeat. They’d rather avoid all of the things that could go wrong without considering all of the things that could go right. Because business owners have unique situations, goals, and resources, advisors must have options available to help owners exit their businesses on their terms, and that includes ESOPs.

Simplifying the discussion of ESOPs can be difficult, but business owners always appreciate an advisor who can explain their options to them. BEI works closely with ESOP professionals and has tools to help its Advisors break down highly technical topics into easily understandable conversations, such as white papers , networking opportunities , talking points, planning deliverables, and training .

An ESOP may not be the solution for all owners, but advisors owe it to their clients to provide them with as much information as possible to help them make informed decisions about their futures.