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Employee Ownership Offers Staffing Firms an M&A Alternative

Tuesday, May 31, 2022 9:02 AM | Denise Downing (Administrator)

Submitted by CSG Partners

Nearly 20% of all US employee stock ownership plans are sponsored by professional services companies. That includes staffing firms and HR consultancies. So what exactly is an ESOP, and why are these benefit strategies so prevalent among staffing industry companies?

An ESOP is an ERISA-authorized, defined contribution plan that invests in employer securities. You can also look at an employee stock ownership plan as a tax-advantaged leveraged buyout of your own company. In many cases, the primary driver for a leveraged ESOP is liquidity, but there are also tax efficiencies on multiple sides of the transaction. Staffing firms – because of their relatively high payrolls – are entitled to accelerated tax deductions compared to an average company.

What drives consideration of ESOPs?

Great businesses often take years, if not decades, to build. Individual legacies are often entwined. With that in mind, a firm’s founders and shareholders may ask themselves, “Do I really want to sell to a third party?”

A strategic sale or private equity transaction usually signals the end of an era. Business disruptions and employee layoffs are common outcomes. For many companies seeking to maintain their culture and independence – and for shareholders interested in potential upside and a continued role with their firms – the ESOP often is a better solution.

How do ESOPs compare to buy-sell agreements?

An employee ownership transaction can be a more tax-efficient tool for acquiring partners’ shares or encouraging a management buyout. In an ESOP sale, a company can borrow money to pay-out a selling shareholder (who can then defer capital gains taxes). The company can then repay that debt using pre-tax dollars.

Can a firm sell a portion of its equity to an ESOP?

Yes, and initial sales of minority interest are common in the staffing industry. Firms want to see the impact of employee ownership on business and get a sense of how the management team and staff will respond. If things go well, the company will sell incremental pieces down the line and eventually become 100% employee-owned. So long as 30% of the company is sold to an ESOP trust, the selling shareholders a eligible to take advantage of the aforementioned capital gains tax deferral.

How are ESOP shares allocated, and are there additional incentive options for participants?

An ESOP is a non-discriminatory plan. So, generally speaking, every full-time employee, so long as they've been with the company for a year or so, is eligible to participate. Every year, shares move to employees accounts. The number of shares they are allocated is based on their salary as a percentage of the total payroll.

If you're looking to use an ESOP as a management buyout tool, you may want to incorporate other components – whether it's warrants, stock options, or stock appreciation rights – so that key managers are going to get something above and beyond.

For additional details, check out this article on how ESOPs work.

Considering an employee stock ownership plan?

An ESOP sale, like any M&A transaction, merits careful planning with relevant accounting, legal, and financial advisors. But, when employee ownership makes sense for all relevant stakeholders, it can drive meaningful benefits for companies – especially those in the staffing industry.

Patrick Trask in a managing director at CSG Partners

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