One of the only issues with using an Employee Share Ownership Plan (ESOP) for Business Succession and Exit Planning is the time these plans can take to fully transition ownership – ESOP’s using a profit share type model and/or employee contribution to fund the plan can take 5, 7 or even 10 years to achieve a substantial transfer of business ownership. For some business owners looking to exit the business and retire, this timeframe is too slow – especially if they haven’t begun planning early enough!
The solution is to accelerate the equity investment in the ESOP and one of the best ways to do this is by using debt (leverage) to speed up the purchase of equity for employees – a leveraged ESOP. Put simply, the ESOP is able to borrow money upfront to make a more substantial initial purchase of equity. The ESOP structure doesn’t need to change but the funding mechanism, rather than being just profit share or employee equity, is now bank debt with the ESOP as the borrower of funds. Normally the funder will seek to take preference in payment of dividends to repay the loan rather than these streaming through directly to employees.
For example, if the ESOP plan is working towards purchasing a business worth $5million, then a profit share based plan will take, say, 7-10 years to make the acquisition (especially if employee shareholders are unable to fund large additional purchases – which is often the case). If however a bank was able to lend $3m upfront to purchase 60% from the founders then the plan is rapidly advanced and the balance will be funded through both dividends (after loan repayments) and further contributions of profit share will allow an accelerated equity investment.
A leveraged (or geared) ESOP may actually combine the best of both worlds – speed of sale of equity and the productivity and performance improvements typical of an Employee Share Ownership Plan – a win-win for both founders and employees.