What Are Your Ow nership Transition Alternatives? The importance of planning in advance for succession Stephanie Carlin, Vice President Anne-Claire Broughton, Principal Prairie Capital Advisors Broughton Consulting Salina, KS Durham, NC
About Us Stephanie Carlin, ASA • Vice President, Prairie Capital Advisors, Inc. • Provides closely-held business owners with an understanding of the value of their business and the options available to them when they are considering ownership transition.
About Us Anne-Claire Broughton • Principal, Broughton Consulting • Business succession via employee ownership & open book management coach with Great Game of Business • Co-Founder and Interim Executive Director of North Carolina Employee Ownership Center (NCEOC)
Succession Planning • A plan for someone to either own or run your business after you leave (voluntarily or involuntarily) • More than half of all small business owners do not have a succession plan • If they have to leave in a hurry due to illness or other factors, the business will likely suffer and potentially not survive in the absence of the owner
8 Key Questions to Ask Yourself When selling a business, there are a number of factors, both economic and non-economic, that can impact the seller’s decision.
Determining Goals & Objectives
Ow ner Transition Paths These paths move ownership in very different ways; however, each has its pros and cons
Strategic Buyer • A buyer already in the industry or in a similar industry, are usually willing to pay more because they can take advantage of synergies with their existing business by eliminating costs and redundancies in operations after closing • The premium strategic buyers are usually willing to pay comes at a cost
Private Equity • Typically will not pay as much as a strategic buyer but can pay a relatively high value • PE firms are buying the business as a going concern and covets the facilities, the management team and the operations as a base for further growth • Opportunity for a “second bite of the apple” for seller
Ow nership Transition Paths
Family Transfers Tax Cuts and Jobs Act (TCJA) became law on December 22, 2017 and effective 1/1/2018. For individuals, the rates expire on 1/1/2026 and reverts back to prior rates unless Congress extends them. Estate and Gift limits (2020) – Individuals can exempt up to $11.58M Couples can exempt up to $23.16 million, (Amounts adjust annually for inflation) Gift tax return – any gift over $15,000 per tax year (as of 2020) requires you to file Form 709 and count against lifetime exclusion (annual limits adjust annually for inflation) Spousal limits – there is an unlimited marital deduction to transfers to your spouse, so long as the spouse is a U.S. Citizen. Non-citizen spousal limits are ~$157k.
Recapitalization While there are many applications for the use of a recapitalization, the primary applications are: • Equity redemption either to take out a shareholder or for liquidity for all shareholders • Dividends to provide liquidity for shareholders and diversify assets and reduce risk • Non-optimal timing for company sale, but liquidity event still desired • Share risk and attract capital for more growth • Prepare the Company for a sale by adding institutional investors
Ow nership Transition Paths
Why Consider Employee Ow nership? • Preserve legacy, jobs, community impact Reward employees who helped build the • company Potential beneficial tax treatment • • Employee owned firms with strong ownership cultures perform 8-10% better and have greater employee retention rates
Considerations for Selling to Employees • Company is privately owned • Company is consistently profitable with good cash flow Management team and operations are strong • • Selling shareholders wish to preserve legacy and reward employees • Experienced advisors are available OBM/GGOB is a big advantage •
Types of Employee Ow nership • Management Buyout (MBO) Employee Stock Ownership Plan (ESOP) • • Worker Cooperative • Newer forms such as perpetual trust/employee ownership trust (EOT )
Employee Ow nership Stats • 7,000 ESOPs in U.S. with 14 million participants • Close to 400 worker cooperatives in the U.S. with about 6,700 participants • More than 9 million employees hold stock options, stock appreciation rights, restricted stock, or phantom stock • Handful of EOTs
Management Buyout • Keeps ownership within the “business family” • Offers a high level of control Preserves the corporate culture, enabling you to • reward your most valued and trusted employees
What is an ESOP? • An employee benefit plan (regulated by ERISA) which can set aside or borrow funds to buy the departing owner’s shares of company stock. These shares are put in a trust and allocated • to individual employee accounts that vest over time and eventually are cashed in when employees retire or leave the company.
ESOP Considerations Tax advantages for owner selling to ESOP • 100% ESOP owned S Corps are tax exempt • • Payments made to ESOP are tax deductible • Can boost company performance, especially if combined with some form of participatory management • Best suited for companies with 20 or more employees and strong cash flow • Highly regulated with significant administrative costs, including annual valuation
Ow nership Transition Paths
What is a Co-op? • A worker co-operative is a business entity (corporation, LLC, trust) owned and controlled by its members • Governed by bylaws that address how members join or leave the co-op and how profits are distributed • Operates on the principal of one member, one vote
Co-op Considerations Potential tax advantages for selling to co-op • • Can be a good fit for smaller companies (fewer than 20 employees) Fewer administrative hurdles than an ESOP (no • annual valuation, etc.) • Works well with highly motivated employees who know the business • Democratic structure • Cost to employee to buy in (can be deducted from paycheck)
What is an Employee Ow nership Trust (EOT)? • A relatively new form of employee ownership common in the UK • A trust holds shares of the company on behalf of the employees, who participate in annual profit sharing • Unlike an ESOP, an EOT is not a retirement plan. Employees are part of profit sharing ONLY during their employment tenure
Employee Ow nership Trust Considerations Allows company to remain employee owned in • perpetuity if desired • Flexible, not regulated by ERISA Low administrative costs, no annual valuation • • No favorable tax treatment Current profit sharing rather than payout at • retirement as done in an ESOP • Allows for (but does not require) democratic governance similar to a co-op • Relatively untested
Steps to EO Conversion 1. Learn about ESOPs, co-ops, perpetual trusts 2. Talk to other established business owners who have gone through a similar transition 3. Conduct a feasibility study 4. Conduct a valuation 5. Hire an attorney to draft the plan 6. Obtain funding for the plan 7. Hire a trustee if needed; draft communications plan for employees 8. Consider open book management
Ow nership Transition Alternatives Sometimes, the best decision is to do nothing… Really? Nothing?
Ow nership Transition Alternatives Holding on while building value may be an alternative • Depending on shareholder objectives, not exiting at the current time may be the right alternative Bigger payday; right timeline for the business; right timeline • for potential buyers • While holding on, you should Focus on value drivers • Both internal and external While holding on, you should build value • Focus on value drivers • Both internal and external You may not have control over drivers, and there are negative drivers to value!
Preparing the Business
Questions? Stephanie Carlin, ASA Vice President Prairie Capital Advisors scarlin@prairiecap.com 785.452.2919 Anne Claire Broughton Principal Broughton Consulting, LLC anneclaire@broughton-consulting.com 919.306.2090
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