Selling Your Business? An ESOP Could be a Wise Decision

Credible valuation of your business's worth.

By using an ESOP, you get a credible valuation of what your business is worth, just as you would if you were giving it to an investment banker to sell. Which means you're selling it to your employees at full market value. The ESOP purchases and gives you the cash for whatever percentage of the company you're selling. And the best part—the tax can be deferred on that transaction.

May cost your employees nothing.

If your employees have no up-front cash to put into the business, that's perfectly okay because the ESOP borrows the money from the bank to pay to the seller. And, then, when the ESOP makes the payments to the bank to repay the money it borrowed to buy the stock, the whole payment becomes tax deductible—which helps the company's tax situation overall.

Reinvest the money tax-free.

The repayments the ESOP makes to the bank are tax-deductible. And so is the cash the business owner receives from the ESOP if rolled over into a qualified investment. The savings are substantial when you consider the traditional way of selling a business for, say, $20 million and having to then pay $9 million in taxes.

The downside.

ESOPs are by no means all sunshine and roses. If you change your mind about doing an ESOP, it is a very complicated process to buy the stock back from the ESOP. The law does not allow ESOPs to be used in partnerships and most professional corporations. Private companies must repurchase shares of departing employees, and this can become a major expense. The cost of setting up an ESOP is also substantial—$30,000 and up, depending on company size. Any time new shares are issued, the stock of existing owners is diluted. And an ESOP representative is going to be on your board making decisions with you about your salary and other important corporate matters.

But all things considered, an ESOP can be an unbelievable tool. You defer taxes. And if you're really loyal to your key people, you've left your business in their capable hands and given them a tremendous opportunity.