After years of building up a business, the day comes when the owner is looking towards retirement and has to decide what to do with their company. Options for a retiring small business owner in California include closing the business, passing it on to family members, and selling the company. Increasingly, retiring small business owners are selling the company to their employees. Transferring control to employee ownership can have a range of benefits to owners who may have never considered employee-ownership as a succession planning strategy.
Silver Tsunami of Retiring Business Owners
The so-called “silver tsunami” of retiring baby boomers will have a major impact on small business succession in the U.S. About half of privately-held businesses are owned by baby boomers. As retirement approaches, these businesses will go through some ownership change. As more businesses change hands, it may become more difficult for retiring owners to have a successful succession plan due to limited options.
Shutting Your Business Down
It can be difficult for an entrepreneur to decide to close the company. However, a changing market or lack of interested buyers can leave some owners with taking the necessary steps to close the company. Business owners may still have to maintain tax, employment, and other business records for a number of years after closing the company.
Transferring the Company to Family Members
Transferring the company to family is the preferred option for many baby boomers looking to keep the company going and provide for future generations. However, it is important for small business owners considering transferring a business to family to understand the possible estate and give tax implications.
Many entrepreneurs are also disappointed to learn that their sons and daughters are not interested in the family business. Alternatively, some family members may not have the skill, experience, knowledge, or discipline to take over and manage a company. Only a small percentage of small businesses are eventually passed down to the younger generation.
Selling the Company to the Employees
A popular succession plan strategy for California small businesses involves transferring the company to employee ownership. Using an Employee Stock Ownership Plan (ESOP), owners transfer shares of the company to employees, generally through the ESOP trust. Employees get these shares as retirement benefits which they can then sell back to the company or trust upon retirement.
Aside from helping employees gain a financial stake in the future of the company, there are a number of practical and financial benefits for an owner selling the company to the employees. This includes tax benefits in the form of deductions for dividends used to pay down the ESOP's acquisition debt and employer contributions.
An ESOP also acts as a way to provide a ready buyer for fair market value. The majority of small businesses looking to sell do not find a buyer and end up closing instead of selling. Others are only offered a fraction of the value asked by the seller. With an ESOP, the owner sells the company to the ESOP for fair market value without even having to publicly list the business up for sale.
Employees, in turn, get a financial stake in the future and profitability of the company. The benefits are generally tax-deferred until the employee retires or leaves the company. Employees who work for ESOP-owned companies also have higher rates of retirement savings compared to other workers.
The longevity of the company and reputation may still be important to owners after moving on from the business. When the company is associated with the founder and owner or the business carries the founder's name, employee ownership is a way to encourage the business operating under the same principles after transfer. The owner can even structure the ESOP transfer in such a way as to transfer the interest over time, to ensure a smooth transition.
Need Help with Succession Planning for Your San Diego Business?
Small business owners looking towards retirement should consider all their succession planning options. If you have any questions about how an ESOP can help your business or other succession strategies, the law firm of Butterfield Schechter LLP is here to help. We are San Diego County's largest law firm focusing its law practice on employee benefits law. Contact our office today.