How Can the Recession Impact Your ESOP Strategy?

August 13, 2020 - When you're ready to exit your business, you have many options for how to go about planning what will happen when (and after) your exit. Employee stock ownership plans (ESOPs) are one of them – but how do you know what's right for your succession plan with the economy slipping into a recession?

"From a timing perspective, ESOP is the same as selling to a third party right now," says Brian Sweeney, CPA, Audit Partner, Client Manager, and ESOP team leader at Redpath. "It still comes down to value."

Whether you talked to your CPA about an ESOP before the recession started or you've done a bit of your own research, here's how to know if an ESOP is right for your succession planning, and if now is the time to start the process.

The Recession Question: To ESOP or Not to ESOP During COVID-19?

Is now the time to choose an ESOP for your business? It depends on a number of factors, including where your company is now and what kind of role you want to play in its future.

"ESOPs can have longer goals in mind, so they're not always trying to drive revenue right away," he says, in contrast to company ownership plans that consolidate decision-making privileges to smaller stakeholder groups.

Over the course of the coronavirus pandemic and resulting recession, Brian has met with clients who've chosen to pause the ESOP transition due to shifting priorities at the company as well as those who've decided to continue the process.

"For some business leaders, it's just the unknown that convinces them to stop," he says. "There are a lot more things in front of them – a lot more decisions to make – and some things just became more immediately important for their business."

For others, their goals, their relationship to their employees, and their expectations of an exit align with a long-term plan for which an ESOP makes sense. During a recession and in times of more economic stability, ESOP viability is typically evaluated on a "case-by-case basis," Brian says.

Because of the bespoke nature of an ESOP, there are some general questions you can ask to determine whether it's right for you and your business and whether now is the right time to start.

ESOP Questions to Ask About Your Company

When discussing ESOP with business owners, Brian says he asks about their motivation for pursuing ESOP: "I go back a step further to ask them about their goals. 'Why an ESOP? Why an ESOP specifically for your business?'" If you're curious about whether or not an ESOP could be the right tactic for your succession plan, ask yourself these questions with a CPA you trust:

• How big is your company? Though headcount isn't an end-all factor in your ESOP viability, Brian says that "a good ESOP candidate has at least 75 to 100 employees" – enough to support and guide the company after your exit.
• What's your relationship with your employees? Your company culture and the relationship you have with your employee base are perhaps the most important aspects of your business to assess when considering an ESOP.  Brian calls them "intangibles" – things that may not correspond to a dollar value, but that can mean all the difference in creating an effective succession plan.
• What do you want for the future of your business? "If you're strictly trying to maximize value" – especially in the short term – "an ESOP may not be right for you," Brian says. An ESOP has the potential to help your employees reap the rewards of self-determination in the long term, but it's not designed for immediate payoff.
• How comfortable are you with debt? Certainly not least of the many concerns you'll have is the financial feasibility of an ESOP. "From a financial perspective, you're going to have debt on the books if you pursue an ESOP," Brian says, underscoring the use of an ESOP as an investment in the future of your company. "It's more of a friendly transaction than the private equity route, so nobody's coming with an equity investment in the form of cash."

You're the only one who can determine whether or not an ESOP is right for your own business exit strategy, but your CPA can provide experienced guidance and help iron out the details. If you're interested in the possibility, review your options with your CPA and think about the short-term commitments and long-term benefits.