Considering an ESOP? Look at one more option before you decide.
An ESOP and a public listing can both keep your company independent, give your people a real stake, and let you turn what you've built into money you can use, gradually. They get there in very different ways. Here's an honest comparison before you commit to either.
Led by Joel Arberman: more than 30 years across Wall Street, Bay Street and his own companies, and 17 companies taken public, several of them his own.
What you're probably trying to do
Owners who look at ESOPs usually want some combination of these:
Step back on your own timeline
Without selling to a competitor or a private equity firm and walking away at closing.
Keep the company independent
Its name, its culture and the people who built it with you stay intact.
Give your people a real stake
Ownership for the employees and leaders who helped create the value.
Turn value into money you can use
Without one buyer setting the price and the terms.
Both an ESOP and becoming a public company can do these things. Where they differ is who sets the price, how and when you get paid, what your employees actually hold, and whether the company can keep growing.
How an ESOP gets you there
An ESOP is a retirement plan trust that buys your shares. An independent appraiser, hired by the plan's trustee, sets the price at fair market value. Most purchases are financed with bank debt and a note from you, so much of what you're owed is usually paid over several years out of the company's profits. Employees receive shares in retirement accounts, and the company buys those shares back when they leave or retire.
ESOPs have real advantages, especially on taxes. Depending on how your company is structured, a sale to an ESOP may let you defer capital gains, and a company owned by an ESOP can pay little or no federal income tax on the ESOP's share of its profits. For the right company and owner, those benefits are hard to match. Ask your tax adviser how they apply to you.
They also have trade-offs. The price can't exceed appraised fair market value. The company usually takes on debt to buy you out. It must keep buying back shares from departing employees, and it needs an annual valuation and plan administration. According to the National Center for Employee Ownership, a typical uncomplicated ESOP transaction costs $100,000 to $150,000 to set up, and more for complex ones.
How going public gets you there
Your company registers its shares and they begin trading, most often through a direct listing on the OTCQB, a U.S. market for smaller and growing companies. You keep running the company and usually keep majority ownership.
The market sets the price
Your shares get a public price that can rise as the company grows, instead of an appraisal capped at fair market value.
You sell gradually
A few years in, once shares trade regularly, you can sell some over time, within securities rules, without selling the company.
Your people hold stock they can value
Shares and options with a market price, not an account balance set by an appraisal once a year.
The company keeps growing
Raise capital, recruit leaders and buy competitors, with stock as part of the price, instead of spending cash flow paying down buyout debt.
The trade-offs are real too. It takes about a year to list. Third-party costs for a direct listing typically run $300,000 to $500,000, plus the ongoing cost of audits, quarterly reporting, a board and outside shareholders. Trading in smaller public companies can be thin, especially at first, and no one can promise a share price.
ESOP vs. going public, side by side
- Who sets the price an independent appraisal at fair market value, updated yearly, vs. the public market, over time
- How you get paid cash at closing plus a seller note paid over several years, vs. selling shares gradually, a few years after listing
- What employees hold shares in a retirement account, paid out when they leave, vs. stock and options with a market price
- Taxes significant potential advantages, vs. no special tax treatment
- Debt the company usually borrows to buy your shares, vs. no buyout debt
- Ongoing obligations annual valuations, plan administration and buying back employees' shares, vs. audits, quarterly reporting, a board and shareholders
- Growth tools mostly cash flow and bank debt, vs. capital raises and stock for hiring and acquisitions
- Time and cost often several months and $100,000 to $150,000 or more, vs. about a year and $300,000 to $500,000 in third-party costs
They aren't mutually exclusive. Some public companies also have ESOPs.
Which is likely the better fit?
An ESOP is likely better if you
- Want to be fully out within a few years
- Value the tax advantages above everything else
- Want employees, not outside investors, to own the company
- Don't want public reporting or outside shareholders
Going public may fit better if you
- Have 5 to 10 more years of drive and want the company to keep growing
- Want the market, not an appraiser, to price your shares
- Want stock to recruit leaders and buy competitors
- Can raise the initial capital from your own network
If an ESOP is the better answer for you, we'll tell you so on the first call.
How it works
Your company is always in one of three modes. The work, and the monthly fee, follow the mode you're in.
Raising
Every engagement starts here: every company going public needs more shareholders, and almost every one needs capital too. We organize the company for life as a public company and prepare your private placement. You raise it, from your own network, and we coach you through it.
Listing
With the capital in place, we manage the process of becoming a public company, usually by direct listing on the OTCQB. We bring in the auditors and securities lawyers you need and coordinate the whole sequence.
Building
Strategic advice whenever we're not running a listing: recruiting with stock, acquisitions, capital, and planning how and when you sell shares over time.
What it costs
Start the process for $10,000. Your company is always in one of three modes: raising, listing or building. The monthly fee follows the mode you're in and your company's size and scope. There's a 90-day minimum, then it's month to month. We also hold equity, so we do well only when you do. If the engagement ends within the first 90 days, that equity is cancelled.
Third-party costs are additional and paid directly to those providers: accounting, audit, legal, stock exchange, transfer agent and filing fees. We'll estimate them once we've seen your financials. As a guide, they typically run:
- Direct listing:$300,000 to $500,000
- Reverse merger:$400,000 to $600,000
- IPO:$600,000 or more, before underwriting commissions
You don't need this money sitting in the bank. In almost every case, we structure a private placement so you and your team can raise capital from your personal and professional networks to cover all of these costs, often with growth capital on top, and sometimes capital for acquisitions too. Your own outlay is nominal: starting the process for $10,000 and our monthly fee while you raise. The people who already know you pay for the rest.
If your raise falls short, you can stop there. Your total cost is typically $20,000 to $25,000, including our fees, you owe nothing further, and any equity we hold is cancelled.
You won't be doing this alone
I'm Joel Arberman. I started as an equity analyst at asset management firms in New York, and at 22 became a partner at a 700-person investment bank, where I learned how buyers and investors value a company. I've spent more than 30 years across Wall Street, Bay Street and my own companies, and taken 17 companies public, several of them my own.
I'm not an ESOP adviser, and I won't pretend an ESOP is never the right answer. What I can do is show you the other path clearly, so you choose with both in front of you.
Questions owners ask
Will I get more going public than selling to an ESOP?
No one can promise that. An ESOP pays fair market value today, mostly over several years. Going public gives you the chance to grow the company first and sell shares at market prices later, but share prices can fall and trading can be thin. We'll walk through realistic numbers for your business.
What happens to my employees?
With an ESOP, they own shares through a retirement plan and are paid out when they leave. As a public company, you can grant shares and options with a market price that they can eventually sell. Many owners care most about this question, so we'll compare the two for your people specifically.
Can I do both?
Yes. They aren't mutually exclusive, and some public companies also have ESOPs. The order and structure matter, so plan it with your tax and legal advisers.
Do I lose control of my company?
As a public company, you stay in charge and usually keep majority ownership. You'll have outside shareholders, a board and reporting duties, and we'll explain exactly what that means day to day.
Is this tax or legal advice?
No. ESOP tax rules are specific and change over time. Talk to a tax adviser and an ERISA attorney before deciding on an ESOP.
Are you a broker-dealer or investment bank?
No. Meraki Partners, LLC is an advisory firm. We don't sell securities or introduce you to investors. Where you need an auditor or securities attorney, you hire them directly, and we help you choose and manage them.
See both paths for your company.
Tell us about your business and we'll give you an honest view of whether going public, an ESOP or neither fits.