This is the fourth in a series of articles that will attempt to dispel ten common misconceptions, or fables, about ESOPs.
ESOP Fable #6: ESOPs are new and untested.
Business owners are often skeptical of an ESOP, considering such transactions new and untested. Yet, ESOPs have been around for almost 40 years. The statutory framework for today’s ESOP was developed by Congress in 1974 to broaden the ownership of capital, and to provide employees with a stake in the ownership of their employers. To induce companies to create ESOPs, Congress developed powerful tax incentives for both existing owners and their companies.
In 1974 there were less than 200 ESOPs. Today there are more than 6,900 ESOPs in place, covering more than 13.5 million employees.
ESOP Fable #7: Lenders won’t be interested in financing my buyout.
Another common misconception is: “My bank would not be interested in financing the buyout of my business by an ESOP.” As a general rule, conventional business lenders will not be interested in financing an ESOP buyout. This can be attributed to their lack of ESOP knowledge and experience, and to a general reluctance for wandering outside of their core business practices.
Specialty lenders, on the other hand, are quite interested in financing ESOP buyouts. In fact, some specialty lenders focus their practices entirely on ESOPs and employee buyouts. And the loan terms for ESOP loans can be considerably more favorable than those of conventional loans. This is due, in part, to ESOP loans generally having lower default rates than those of any other type of commercial loan.
Further, your company will have the ability to deduct from taxes not only the interest paid on the buyout loan, but also the principal payments. This lowers the company’s effective borrowing costs by roughly 30%. As a result, the ESOP can be in a better position to buy your shares when compared to a third party acquirer, who will not have access to such favorable tax treatment.
Next month’s article will tackle: ESOP Fable #8: I fear that my employees can sell their stock to someone else.
As ever, if you know of a business owner who’s thinking of selling or buying a business and who might benefit from a free, confidential, consultation with us, have them contact me directly.
By: Mike Ertel, Transworld M&A Advisors