At some point in a Company’s life cycle the topic of succession planning will arise. For some businesses this succession plan is centered around passing ownership from one generation to the next; for others it could be discussing a sale to a strategic buyer; some businesses start the succession planning discussion only to determine they want to become an acquirer and continue to grow. At the end of the day the “success” of a succession plan, is achieving the very best outcome for the business and business owner. All too often within the exit strategy conversation, there is one key piece to the puzzle that isn’t talked about enough. What happens to your employees after the succession plan is enacted?
Interestingly enough, 75% of owners “profoundly regret” selling within one-year post-transition1. The reasons for this regret range from loss of identity and purpose, to hiring a bad sell-side advisor and wondering if there was money left on the table. However, one of the most common issues cited is dissatisfaction with how their former employees were treated post sale. While traditional exit strategies largely result in a dissatisfaction with how former employees are treated, it is pretty well documented that ESOPs result in increased employee satisfaction. Before we dive into that, it’s important to highlight the single biggest cash flow item an ESOP unlocks. A 100% S-Corp pays no federal income tax.
It’s well documented the company will experience an increase in productivity based on the broad-based sense of ownership across the organization. An ESOP sees productivity increase of 2.2% in the year of implementation. Within the first ten years of implementing an ESOP, an average ESOP company would grow 33% larger than a similar non-ESOP company2. Beyond the productivity increase, ESOP companies also see significantly lower turnover; when implementing an ESOP and empowering your employee base, voluntary turnover was found to be reduced from 13% per year to 2% per year3. It’s hard to argue that an ESOP doesn’t only retain a company’s culture, but often improves a company culture upon implementation.
So, the culture is great but how are ESOP employees compensated?
ESOP employees consistently report that they are compensated higher than their counterparts in non-ESOP companies. Beyond their compensation, ESOP employees report having a significantly higher retirement balance than their non-ESOP counterparts. This higher balance is often a direct result of the retirement benefit being accumulated within the ESOP. The coolest thing about that, is an ESOP retirement plan is 100% employer funded, meaning the benefit received comes at no cost to employees. That “free-benefit” is no small amount either, the total wealth held in ESOP’s is an impressive $1.8 Trillion Dollars or $180K per employee. Digging deeper, Employees 55+ or with 10 years of participation in the ESOP see the average account balance balloon to $315K3.
So, all our employees who stick with us will have a great new benefit? Fine, but how do I incentivize key management?
During the COVID-19 Pandemic the National Center for Employee Ownership performed a study which found ESOP companies were much less likely to see retaining key employees as a very large challenge. Only 6% of the ESOP respondents mentioned this as a very large challenge compared to 22% for their non-ESOP counterparts4. Why are ESOP Companies so much better at retaining key employees if the ownership is more widely disbursed? Outside of the culture and retirement benefits discussed above, many ESOPs implement management incentive plans (MIPs) for their key employees. While the MIPs implemented vary from company to company, many ESOPs adopt a form of stock appreciation right (SAR’s) as their MIP. A SARs plan functions very similar to a stock option in which key employees are granted stock at the current value and entitled to receive a benefit for any growth the stock achieves during the vesting period. By implementing such a plan, the company is able to: (1) further align key management and the company’s financial interests, (2) incentivize the employee to stay through the vesting period to receive their benefit and (3) grant key employees a cash bonus that will be paid upon vesting. This plan isn’t unique to ESOPs, frankly, any company can set up an equity-based MIP plan. But given ESOPs are required to obtain an independent valuation annually, they are uniquely equipped to determine the value of the stock and thus the amount key management is entitled to.
At the end of the day most M&A professionals will tell you that there are pros and cons to all business transitions and figuring out the best possible outcome for your client is the #1 priority. When you’re figuring out that best possible outcome, just don’t forget to keep “What happens to my employees after the succession plan is enacted” high on your checklist.
1 – Exit Planning Institute – How to start the exit planning conversation.
2 – NCEO – Largest Study Yet Shows ESOPs Improve Performance and Employee Benefits
3 – Aspen Institute – What We Know from Recent Research
4 – NCEO – COVID – New Research: Employee Ownership in the US Food System During COVID-19
Troy Starr, Director
Troy Starr is a Director in the firm’s Mergers and Acquisition and ESOP practices. Prior to joining Lazear Capital, Troy was the Director of Accounting at a publicly traded retail company, where he led multiple teams overseeing end to end operational accounting.
Troy also spent several years within the Ernst and Young audit practice. Serving a multitude of clients, ranging from fortune-500 retail to mid-market manufacturing and mining. Troy is a graduate of The Ohio State University’s Fisher College of Business and is an active Certified Public Accountant in the state of Ohio.
