Business owners sometimes sell to employees to keep their company intact
Owners who sell to employees can maintain legacy
In early 2000, Michael and Lynn Terry started a business selling horse trailers that were lighter than their competitors’ and customized to each client’s needs. Nearly two decades later, their company, Cimarron Trailers, with tens of millions of dollars in sales, employed more than 130 people in Chickasha, Okla., and their trailers were sold at 30 dealerships across the country.
And they wanted to retire.
But as the couple, who met in high school, contemplated a sale, they faced a conundrum: They had offers from dealers and competitors to buy their business; they also had an offer from a private equity firm for a price so high they were shocked. But none of those offers guaranteed that Cimarron would continue as a business with its 130 employees working in its community.
“We thought, this has got to go on,” Lynn Terry said. “We’re one of the bigger employers here in Chickasha.”
So the Terrys went with a less lucrative option a couple of years ago — selling their company to their employees. But it ensured that their company would stay in Chickasha and their employees would continue to have jobs. It also allowed them to be paid for the company they created and retire in their community.
“Was it easy? No,” Lynn Terry said. “But it was the best for the future of Cimarron going forward.”
Employee- owned companies are still a small segment of the U. S. corporate landscape. The number has stayed at about 6,500 for the past decade, said James J. Bonham, president and chief executive of The ESOP Association, the trade group for employeeowned businesses. But he said there were now some 10.5 million employees who own stakes in the companies they work for, through employee stock ownership plans, or ESOPs, as they’re known.
For families who own businesses and are wondering about their next step, selling to employees is an opportunity that analysts say owners should consider. It keeps the company intact, it has tax benefits for the company and the owners, and it allows the owners to sell without worrying that the business might be gutted and sold off in parts.
Yet it does have downsides. It’s a complicated structure, which comes under the regulatory scrutiny of the Labor Department, because employee ownership stakes are held in their retirement plan until they leave the company.
“It’s a complicated transaction,” said Jere Doyle, family wealth strategist and senior vice president at Bank of New York Mellon, a wealth management firm. “If you talk to 100 people, you might get eight or 10 who go through the transaction.”
But he said it’s a structure, given its tax benefits, that could increase in popularity if federal tax rates begin to rise. “ESOPs may become more popular next year if the Democrats hit the trifecta and raise the capital gain rates to 39%,” Doyle said.
When a family sells a company to a competitor or an investment fund, members run the risk that the identity of their company will die with the sale. It may become a division of someone else’s company or worse, it may be combined with something else and sold off, never to exist again.
An ESOP allows the company to continue in its own right, guided by the employees who are the new owners. “If I sold my company to my competitors, do you think Ray Baker’s name would ever be said again?” said Ken Baker, chief executive of New Age Industries, the flexible tubing company his father, Ray, started in 1960 and his brother operated until he took it over. “We have a bust of my father in the lobby. His legacy and my brother’s legacy continue on.”
The Terrys initially thought their daughter and son- in- law might take over the business, but when that did not happen, they thought about how some of their key employees, such as Ben Janssen, the current president, could continue to run it.
In their case, Cimarron was bought by another ESOP, called Folience, which made the transaction quicker.
“There was a template in place,” Michael Terry said. “Folience gets together once a month to talk about their failures and successes. We didn’t have that.”
For the employees, owning the company gives them a boost to their retirement income, as long as the company continues to grow. With an ESOP structure, the money that goes into it is tax- free, increasing the amount put away for the employee- owners.
During the pandemic, employee- owned companies performed better in retaining jobs for workers than nonemployee- owned companies, according to research by Rutgers University’s School of Management and Labor Relations and the Employee Ownership Foundation. They also maintained salaries and wages at a higher rate.
Money from the sale goes to the person who started the business. But the advantages come in many forms, including deferred taxes on the money put into an ESOP and the timing of the payout. Doyle said more sophisticated structures allowed sellers to roll over some or all of the sale proceeds into securities, known as qualified replacement property. If the seller doesn’t need the money, any capital gains in those securities will be erased at death, and heirs will inherit the portfolio free of capital gains or income tax.
There are negatives to this ownership structure.
For one, the seller is not going to get the highest price when the employees buy the company. Nor will those employees see the company’s value skyrocket the way it could if a competitor bought it.
“We pay fair market value,” said Daniel Goldstein, chief executive of Folience, the ESOP that holds Cimarron Trailers as well as an ambulance manufacturer and a newspaper publisher, both in Iowa. “ESOPs are prohibited from paying a premium.”
That lower value ensures that employees are not overpaying for what will be the bulk of their retirement savings. It can also mean that these companies will later become ripe targets for the private equity funds that their founders avoided.