Succession planning is a critical aspect of managing any business, particularly when it comes to transitioning ownership. An Employee Stock Ownership Plan (ESOP) offers a unique and effective method for this transition while providing numerous benefits to the selling shareholder, the business, and its workforce. With interest rates at over decade-long highs, geopolitical uncertainty, and other economic headwinds, ESOPs are gaining traction in comparison to other mergers and acquisitions (“M&A”) alternatives. 

Considering an ESOP for your Business

An ESOP is a qualified benefit plan that buys and holds stock in a sponsor company for the benefit of qualified employees. Utilizing an ESOP allows a business owner to sell all or a portion of his/her stock in a tax-advantaged way, while preserving his/her legacy. It allows selling shareholders to defer or even eliminate capital gains taxes from the sale, depending on the structure of the transaction. Additionally, the sponsor company can reduce or eliminate income taxes with ESOP ownership. 

Participation in an ESOP incurs no cost for employees; instead, the value is allocated annually and vested gradually. ESOPs serve as a tool to attract and retain top talent, offering retirement planning and fostering a sense of loyalty and commitment among employees. It also grants selling shareholders the opportunity to retain control over daily operations or maintain a board seat, if desired.

“That’s the beauty of an ESOP, it checks a lot of boxes,” says Jim Swabowski, Senior Vice President of Wintrust ESOP Finance. “Navigating through that ownership transition, with all the different options available can be a daunting task. But every year that owners, particularly baby boomers, get older, they are doing their families a disservice by not putting a plan in place.”

Understanding Interest Rate Dynamics

The recent surge in interest rates has had a significant impact on the M&A market, and deal volumes were considerably down in 2023.  While valuation and deal structures have been impacted by rising interest rates in ESOP structures as well, ESOP transaction volume has been impacted to a lesser extent. 

“The value proposition of an ESOP remains unchanged regardless of the interest rate or economic environment,” said Swabowski. “It appears the number of companies exploring ESOP as a succession alternative continues to grow. No matter the economic cycle, we’ve seen a lot of success with the ESOP model.”

Putting the Plan into Action

The Wintrust ESOP Finance Team specializes in offering unique financing solutions to ESOP-owned companies across the country.

• Utilizing a relationship-based approach, the ESOP Finance Team is involved with ESOP-owned companies on a day-to-day basis, providing the full support and resources of a dedicated ESOP team.
• The ESOP Finance Team frequently collaborates with many different niche lending groups, such as Construction, Engineering & Architecture, or Insurance Banking, to provide an unmatched level of expertise in both the industry and ownership structure.
• The ESOP Finance Team utilizes consultative and educational methods to ensure ownership groups and management teams are well-equipped for long-term success.

ESOPs offer a compelling option for succession planning, providing a mutually beneficial solution for both selling shareholders and employees, even in a rising interest rate environment. By providing financial benefits to the employees, ESOPs can ensure the continuity of the business and motivate the workforce, all while providing tax advantages for all parties involved. However, implementing an ESOP requires careful planning, consideration, and ongoing management. For companies that have utilized this transition alternative, ESOPs have shown to be a powerful tool for ensuring the long-term success and sustainability of the business.

As a partner to middle-market companies that have or are interested in learning about an ESOP, a fundamental principle of our practice is to be proactive in capital planning. Trust the experienced team at Wintrust to help you proactively review your succession planning alternatives to ensure a successful transition.