Exit Alternatives – ESOPs and More

For many North Carolina based business owners, planning an exit or retirement transition is not simply a matter of money. Many owners have spent years building their companies with a team of valued employees, and upon exit they want to assure those employees a solid future. Beyond selling your business to a strategic or financial buyer, there are other alternatives that can create financial liquidity for you as an owner AND positively impact the team and lay the foundation for your legacy and growth for those involved.

While not right for every business, one such alternative to consider is an Employee Stock Ownership Plan or an “ESOP.” An ESOP, by definition, is a qualified defined-contribution employee benefit plan that is designed specifically to invest in the shares of the business or sponsoring employer.

So what do we mean by qualified? ESOPs are “qualified” in a way where the sponsoring company and the selling shareholder(s), receive a tax benefits for selling all or a portion of the business to their employees. ESOPs are a commonly deployed corporate finance strategy that can benefit the employees as they become invested in the success of the business by effectively becoming shareholders and direct beneficiaries of the growth in value.

Some owners may feel that asking their employees to directly purchase ownership in the company is not ideal, however with ESOPs, the employees receive the ownership shares for minimal upfront direct investment. Typically shares are allocated based on the employee’s salary. Not every employee receives the same quantity of shares or rights. To mitigate management problems, voting rights can be reserved for senior management who may hold the a greater share of stock.

Another technique to share the growth in value of the company with employees uses phantom stock; which provides a mechanism to give employees an opportunity to realize the benefits of an exit without actually giving them physical shares in the business. More clearly defined, phantom stock is a contract between a corporation and the recipient, or phantom stock shareholder, that gives the recipient the right to earn a cash payment at a designated time triggered in association with a particular event such as a full or partial exit. While no actual stock is granted, the payment is to be in an amount tied to the market value of an equivalent number of shares of the corporation’s stock. The phantom stock value goes up and down as the value of the actual stock varies.

Another similar method is the use of Stock Appreciation Rights or SARs. A stock appreciation right can be a bonus payment to employees mirroring the appreciation of the company’s stock over a defined period of time. SARs incent employee loyalty and alignment as they are paid a greater sum of money as the value of the stock increases. In the case of SARs, employees do not pay the exercise price like they would with a regular stock option. Instead, they simply receive the sum of the increase in stock as cash.

Each of the two previously mentioned techniques to incentivize employees can be used in conjunction with a recapitalization of the business to create shareholder liquidity and align the long-term economic objectives of the go-forward employee base ….to continue to increase the value of the remaining portion of your ownership for an eventual full exit when the time is right.

When considering a partial or full sale of your North Carolina based business, know that there are a number of options to compensate and reward your employees for their contribution and dedication, without impacting your ability as an owner or founder to realize and monetize the full value you have created.