How Does a Management Buyout Relate to an ESOP?

A “management buyout” is a buzz phrase currently used in many business discussions, and for good reason.

The greatest generation of entrepreneurs in Canadian history will retire within the next 10 to 15 years, and these men and women are looking for a way to exit their companies in a way that meets their needs.  Not only do they want to leave with an abundance of retirement funds, they also want to leave a legacy.  They want to ensure the business they built and nurtured will thrive and continue to support the employees and enhance the community.

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You would think it should be easy to achieve these needs by selling the company to a third party.  Not so.  Studies show that only 1 out of 4 privately held companies will be successfully sold.  And of those that sell, many are restructured, or due to a change of ownership, the culture is drastically, and often negatively altered.  What about the original owner?  Studies indicate that, of the owners who sell their companies, over 75% of them regret their decision and are unhappy within 12 months of the sale.

There must be another way to deal with this inefficiency? It has a huge cost in regard to human capital, lost dreams, and deflated aspirations, for the business owners and their valued employees.

An Employee Share Ownership Plan (ESOP) is one alternative that can make a significant contribution to solving these issues.  Unfortunately there is misunderstandings about ESOPs by both business owners and their professional advisors (primarily accountants and lawyers).

The first misunderstanding is the relationship between a management buyout and an ESOP.  ESOPs have two broad categories:  key person or broad-based plans.  A key person plan is synonymous with a management buyout.  This plan selects only key senior persons to be part of the transition plan, yet it is still an ESOP.  A broad-based plan allows all employees in the company who meet eligibility requirements, to be part of the plan.  Typically in a broad-based plan, the majority of the allocation of shares goes to the key people.  It ensures that those with greater levels of responsibility and business acumen have the opportunity for greater levels of ownership.

The second misunderstanding (by professionals mostly) is that the success of an ESOP depends upon how it is incorporated into the culture of the company.  It is one thing to complete the legal documentation; it is quite another to have the plan accepted enthusiastically by a large percentage of the eligible employees.  In this game of business, employees will either choose to participate – or not.

Studies show that a participative ESOP will grow a company between 8 to 12 % per annum while a non-participative ESOP can actually decrease growth by 6% per annum.

Consider this example:  Two identical companies implement ESOPs.  One is participative and the other is non-participative.

In five years, the participative ESOP company has grown 40% to 60%.  It has higher revenues, profits, and an engaged workforce.  It also has higher retention rates and attracts highly engaged employees that fit the culture.

The non-participative ESOP company has declined 30%.  It has lower profits, high turnover rates, and struggles to stay in business.

Which result would you choose?

If you’re one of those business owners seeking an exit strategy on your terms, an ESOP may be an attractive alternative, as a key person, management buyout ESOP, or a broad-based, all-inclusive ESOP.

Regardless of who supports you to implement your plan, we invite you to question them early-on about how they will assimilate it into the valuable culture of your company, through employee engagement in the design, communication, and education process.

If that’s not their style, find someone else.  It is critical to your success and satisfaction.

By Perry Phillips, President of ESOP Builders Inc.

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