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5 Reasons ESOPs Are an Excellent Option for Succession Planning

An employee stock ownership plan (ESOP) helps meet principals' dual challenges of retaining talent and planning an exit strategy.
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5 reasons esops are an excellent option for succession planning

Independent agency principals have a lot on their plates. Besides navigating uncertain times, the need to grow, recruit and retain talent and plan an exit strategy are constants. Therefore, agency owners should consider a vehicle to meet these challenges. Step forward: an employee stock ownership plan (ESOP).

An ESOP is an employee benefit plan in which the owners sell some or all their shares to a trust at fair market value. The owner receives cash for their shares, and each employee receives a financial interest in the stock held and owned by the trust.

Be aware that ESOPs are not for agency principals looking for a quick exit or to extract the last dime. They're for well-run firms with at least 20 employees and a principal who understands the unique benefit of the ESOP.

If this sounds like you, here are five reasons an ESOP is advantageous for independent agency principals:

1) Retain control. As principals sell stock to the ESOP, employees gain a sense of ownership. But simultaneously, principals can retain control of their firms because they're not required to sell all of their stock, all at once. This provides flexibility to decide whether and how they want to stage this process. They can even use the ESOP as a vehicle to acquire another agency.

2) Friendly perpetuation. ESOPs are a structured, tax-favored way to sell a portion or all of the agency to a “friendly buyer"—the ESOP trust. In fact, the tax code encourages ESOPs with a generous tax break. Studies show that employee-owned firms enjoy productivity gains, success and employee retention. That's important, especially these days when private equity buyers are seeking to hire an agency's best talent but don't offer ownership.

3) Tax treatment. Agency owners can elect to defer the gain on their stock sale to the ESOP if certain rules are met. This allows them to maximize their post-sale, after-tax proceeds. On an after-tax basis, selling to an ESOP can approach the prices paid by the big acquirers.

ESOPs usually borrow money to purchase shares. The agency repays the loan by contributions to the plan with funds that are not taxed.

4) Staged perpetuation. ESOPs aren't for principals in a hurry. Rather, they're a terrific vehicle to create and manage a staged exit strategy. Agency principals can relinquish ownership over the course of some years, allowing time for rising stars to flourish in their new or expanded roles. At the same time, they are handed the opportunity to increase the agency's value.

5) Preserve a legacy. Agency principals often express “seller's remorse" after they've sold to an external buyer. Sure, they may have been paid well, but now they're removed from a business they've built up over decades. Ultimately, ESOPs make sense for independent agency principals who remember how they gained ownership and want to reward family members and employees who subsequently helped them build their business.

While not always a panacea, ESOPs are an attractive option that should be strongly considered to boost productivity and employee retention while meeting an agency's perpetuation needs.

Robert Pettinicchi is executive vice president and chief lending officer for InsurBanc, a division of Connecticut Community Bank, N.A. He developed InsurBanc's loan products for independent agents. An expert on agency mergers and acquisitions, agency perpetuation and financing, he has presented at numerous venues nationally.

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Friday, July 1, 2022
Perpetuation & Valuation