Exit planning strategies for business owners
Don’t be caught off guard by the ‘silver tsunami’
Sue Crockett | September 2021 Footnote
Editor's note: Updated September 1, 2021
As baby boomers approach retirement age, the Minnesota business landscape faces the so-called “silver tsunami,” signaling the exit of a significant share of the workforce. But there is a beacon of light.
There are approximately 53,000 business owners older than 55 in Minnesota and, by all accounts, most will exit their businesses in the next three to five years. However, 60% of these business owners do not have a succession or exit plan, and 40% do not even know what their options are. This is a crisis!
These firms employ close to 600,000 workers and generate nearly $124 billion in revenue. Their impact on our communities and economy is enormous. On top of that, finding a buyer for a business is becoming increasingly difficult, with as few as one in five businesses selling. Without a buyer or other exit plan, business owners often choose to close their businesses altogether, resulting in employee layoffs, the loss of the owner’s personal retirement security and increased disparities in ownership and wealth.
Start at the beginning
So, when should a business owner start thinking about creating an exit plan? Sooner rather than later! As the business owner’s CPA and trusted adviser, you are uniquely positioned to help them start planning for the business’s future and to advise them on what steps to take and other factors to consider.
Kyla Hansen, CPA, CVA, a partner at John A. Knutson & Company PLLP, works with business owners on developing succession plans and often recommends employee ownership as an option to consider.
“When owners are planning their exit, they frequently want to give back to their employees who helped them be successful,” she said. “Employee ownership is a great way to do that!”
Before an owner begins the process of choosing an exit planning model, they should have their company valued and have a feasibility study completed. This is an important first step to take to determine whether various exit planning options, such as employee ownership models, will be a good fit.
What outcome is being sought?
Next, there are many questions business owners, whether retiring or moving on to a different venture, should answer in choosing a succession model. Here are some to consider:
- When do they want to exit the business? Is it one year, three years, five years, today?
- Do they want to sell but continue to work in their business for a few years?
- Who is their most trusted adviser they can depend on for this transition?
- Is their company profitable?
- Does their company have any debt?
- Is their legacy as an owner important to them? They have spent years building up the business they created; do they want it to continue?
- Do they want to reward their employees for helping them build and sustain the business?
- Is their workforce engaged and dedicated? Is there a solid leadership team in place?
- Is the business’s place in the community paramount to the well-being of the employees and the community?
Once an owner has considered the answers to these questions, you can help them understand their different options as they look to transfer ownership of their company. A few choices are:
- Selling to a private equity firm, a third-party private buyer or using a management buyout.
- If the company has more than 20 employees, the owner may want to consider an employee stock ownership plan (ESOP) or an employee ownership trust (EOT).
- If the company has fewer than 20 employees, a worker-owned cooperative could be a good fit.
Let’s take a closer look at these options.
Private equity/third-party buyer
You are likely familiar with both of these types of exit-planning tools. For some business owners, these options check all the boxes for their objectives in selling their business. However, for others, selling to a private equity firm or third party does not fit all their objectives. They may struggle to find a suitable buyer and worry about things like having the business moved, sold off or merged with another company and the job losses that come with those possibilities.
Employee stock ownership plan
There are more than 6,500 active ESOPs nationally, representing more than 14 million employee-owners. ESOPs are a form of retirement plan for the employees, somewhat like 401(k)s, except the invested dollars are almost always contributed by the employer, not the employees, and those dollars are used to purchase stock in the company where the employees work. Importantly, like a 401(k), an ESOP also receives special tax treatment. If a company is classified as an S Corporation, whatever portion of the company is owned by the ESOP pays no federal or Minnesota corporate income tax. That’s right — if an S Corporation is 100% owned by its employees through an ESOP,
the government does not tax its profits at all! The owner selling the business makes a competitive profit on the sale, creates wealth equity for all workers and can stay involved in the business after the sale, if desired.
“CPAs need to understand the benefits of an ESOP as an exit strategy because it is a great alternative to a financial buyer, strategic buyer or management buyout,” said Dan Markowitz, CPA of Boulay. “CPAs tend to shy away from recommending an ESOP transition because of their limited understanding of ESOPs. ESOP transitions have significant tax advantages, and, with the right planning, an ESOP can be a great exit vehicle for selling shareholders. To determine if an ESOP is the right exit, we work with clients on an ESOP feasibility study to make sure it will work for both the company and the selling shareholders.”
Employee ownership trust
To create an EOT, an owner sells their company to a perpetual trust for fair market value, with the requirement that all profits above those needed for reinvestment in the business go to the employees. Employees do not pay for their ownership benefits, and they receive a share of the company’s annual profits while they work at the company.
An EOT succession allows a business owner to sell their company, as well as:
- Ensure it won’t be acquired by a larger company that takes the technology it wants and then closes the company, forfeiting all the local jobs.
- Ensure the profits won’t be siphoned off to satisfy shareholders; profits will be shared with employees and to finance the growth of the company.
EOTs lack the tax benefits of ESOPs but are also
significantly less expensive to create and administer than an ESOP. They also allow for a longer legacy for the business.
Worker-owned cooperative
This is not your grocery- or farm-type cooperative; it is instead owned by the workers. In transitioning to a worker-owned cooperative, the company is sold to the employees and, again, the owner receives fair market value. These are companies that are governed democratically, with employees voting for the board of directors, for company leaders or even on specific decisions for the organization, depending on the chosen cooperative model. Each employee receives one voting share. As with an EOT, the employees benefit while they work at the company. There are more than 400 worker-owned cooperatives in the U.S., but just a handful in Minnesota. However, worker co-ops can be a
great option for smaller companies or those who want to prioritize workplace democracy.
Preparing for the tsunami
Over the years, Hansen has expanded her knowledge of different forms of employee ownership.
“As an adviser, I feel it is important to be informed on employee ownership so I can properly advise my clients,” she said. “In addition to ESOPs, there are other forms of employee ownership. Now that I am educated on the other forms, I am able to better provide advice to clients on what their options are so they can make informed decisions.”
As boomers plan their exits from business ownership, these sellers need to determine what is most important to them for their legacies, employees and communities. If selling to a private equity firm or third-party buyer is not viable, or if doing so is not the best choice for the business or employees, choosing an employee ownership model can help both the owner and employees keep the business alive in a mutually satisfactory and profitable way.
Sue Crockett is the executive director of the Minnesota Center for Employee Ownership (MNCEO). MNCEO serves as a free, unbiased source for education and resources around all forms of employee ownership. You may reach Sue at scrockett@mnceo.org.
