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Small business owners looking to convert their organization to an employee-owned company may have an easier path thanks to a new law signed by President Donald Trump last year.
Before the law was passed in August 2018, the rules surrounding loans backed by the Small Business Association (SBA) used to create Employee Stock Ownership Plans (ESOPs) often discouraged small business owners from using this valuable succession-planning and employee-retention tool. The new provisions, found in the John S. McCain National Defense Authorization Act, streamline and modernize some of the rules that previously had made ESOP financing cumbersome—or in some cases prohibitive—for many small business owners.
ESOPs as an Exit Strategy
As baby boomers approach retirement, more small business owners are looking for ways to generate liquidity for their equity while also rewarding employees and maintaining the corporate culture that the owner worked so hard to build. ESOPs can be an effective tool for accomplishing all of these goals. According to the National Center for Employee Ownership, there are 6,717 ESOPs operating nationwide covering 14 million participants with $1.3 trillion in assets.
ESOPs are a type of qualified defined contribution plan that invests primarily in company stock, which is distributed to employees. The company either borrows money or uses cash on hand to purchase the owners’ shares on behalf of the employee participants. Then the shares are distributed to employees’ ESOP accounts, which are held in a trust, over time. When participants leave the company or retire, the stock they own gets cashed out of the ESOP.
How the New Law Encourages ESOPs for Small Businesses
The new law includes several significant changes that will make it easier for business owners to secure financing through the SBA to establish an ESOP. It also contains a provision for the SBA to create outreach programs as well as an interagency working group to promote employee ownership.
The most significant changes in the law include:
Marvin and Company Insight: Time to Take a Second Look at ESOPs
Now that the SBA loan process has been streamlined and some of the eligibility rules have been eased, owners of small businesses who previously feared that SBA financing, or even traditional senior financing vehicles, would not be available to establish an ESOP may want to take a second look. In addition to the more borrower-friendly underwriting process, the opportunity for the owner to remain involved in the company after the establishment of the ESOP may make the plans significantly more appealing for owners who want to gradually phase out of the business.
In addition to the new rules, there are many other factors to consider when evaluating whether an ESOP is appropriate for your organization. If you are interested in learning more about how an ESOP could affect your business, your employees and your exit strategy, please contact your Marvin and Company, P.C. representative.