Passing the Torch: How NH Business Owners Can Benefit from an ESOP

With a large portion of New Hampshire’s small-business owners nearing retirement, 38 percent of proprietors are 60 or older, according to the NH Small Business Development Center, many companies in industries ranging from technology and advanced manufacturing to construction are facing a critical moment for succession planning. More businesses are exploring ESOPs as a way to keep ownership local, reward long-standing employees, and offer business continuity.

Transitioning a company to an ESOP can make sense in several scenarios and benefit owners and employees. It can create retirement benefits for dedicated employees through ESOP contributions or provide a pathway for an owner to retire while keeping the business locally controlled.

Retirement savings benefits

Research, including studies by the National Center for Employee Ownership (NCEO), shows that ESOP participants tend to have higher retirement account savings compared with non-ESOP employees and enjoy better job security. ESOP companies’ retirement contributions are about 2.6 times that of companies offering only 401(k) plans, giving employee-owners a significant boost in planning for their own retirement.

Tax advantages

ESOPs also provide meaningful tax advantages for owners. Business owners can defer, and in some cases eliminate, capital gains taxes by selling stock to the ESOP. For S-corporations, a 100% ESOP-owned company can eliminate federal income tax. According to the NCEO, to the degree an ESOP owns the company, there is no federal tax due because the ESOP trust is tax-exempt, and most states follow this rule. Because New Hampshire generally conforms to federal tax treatment of ESOPs, these tax benefits are particularly meaningful for Granite State companies.

Whether you are a potential employee-owner considering a buyout or an existing business owner weighing tax advantages or succession planning options, an ESOP transaction starts by building an advisory team, including a banking partner experienced in ESOPs.

Key Considerations for ESOP Planning

Leveraged vs. Non-Leveraged ESOP: If a company has the funds to purchase its stock outright, it is non-leveraged, while stock purchased through financing is considered leveraged. Circumstances may change over time, so understanding ESOP funding early on can help prepare for future needs.

Choosing the Right Lender: ESOPs present unique lending considerations. Experienced ESOP lenders know how to evaluate cash flow, management continuity, and collateral in ways traditional lenders may not. Once an ESOP is formed, the trust has no assets on the balance sheet, and the principal owner is often preparing to retire. Partnering with a lender familiar with ESOPs is critical to navigating these complexities.

There are many ways to structure the buyout. Finding a solution that benefits all parties, the seller, ESOP, and lender, requires a strong working relationship and a clear understanding of each party’s needs. A knowledgeable ESOP lender, working with your CPA, can help answer key questions such as:

• What are the ESOP tax benefits and cash flow advantages for repaying debt? What are the benefits for the selling owner?
• How does an ESOP impact cash flow, reduce tax liability, and offer employees ownership and profit-sharing benefits?
• What requirements does a lender want to see, such as a detailed business plan, succession plan, and projected liquidity?
• Is there a business structure, such as an LLC or S-Corp, that is most advantageous for the ESOP?

Federal Loan Programs: Yes, there are options. In May 2023, the SBA removed a key barrier for ESOPs: companies no longer need to put in a 10% equity injection when an ESOP takes a controlling stake. (Groom Law Group, Menke) As of June 2024, lenders can skip a separate SBA-specific valuation and rely on the ESOP’s ERISA valuation. (Small Business Administration, NCEO) Looking ahead, upcoming SBA guidance will make 7(a) loans even easier for ESOPs to access, though the loans still cannot cover the cost of setting up the ESOP itself.

For New Hampshire business owners, an ESOP can provide a path to retirement, preserve local ownership, and reward loyal employees. Partnering with the right advisors and lenders early can make the transition smoother and set the business up for long-term success.

About the author: Nicole Howard is a VP, Commercial Banking Officer with Machias Savings Bank based in Manchester, NH. She partners with businesses across New Hampshire to deliver customized financial solutions that support long-term growth and operational success.

Sources

1. NH Small Business Development Center – Data on small-business owner ages in New Hampshire: https://www.nhsbdc.org
   
2. National Center for Employee Ownership (NCEO) – Research Findings on Employee Ownership: https://www.nceo.org/research/research-findings-on-employee-ownership?utm_source=chatgpt.com
   
3. NCEO – Retirement Savings Crisis and the Role of ESOPs: https://www.nceo.org/research/the-retirement-savings-crisis-and-the-role-of-esops?utm_source=chatgpt.com
   
4. NCEO – S Corporation ESOPs: https://www.nceo.org/what-is-employee-ownership/esops/esops-s-corporations?utm_source=chatgpt.com
   
5. NCEO – ESOP Tax Incentives and Contribution Limits: https://www.nceo.org/articles/esop-tax-incentives-contribution-limits?utm_source=chatgpt.com
   
6. Groom Law Group – SBA Guidance on ESOP Financing: https://www.groom.com/resources/small-business-administration-guidance-streamlines-process-for-loans-to-esops/?utm_source=chatgpt.com
   
7. Menke & Associates – New SBA Guidance for ESOPs: https://www.menke.com/esop-archives/new-sba-guidance-enhances-financing-opportunities-for-esops/?utm_source=chatgpt.com
   
8. Small Business Administration – Procedural Notice on ESOP Loan Valuations: https://www.sba.gov/document/procedural-notice-5000-858322-7a-504-loans-cooperatives-valuation-requirements-7a-loans-esops-changes-ownership?utm_source=chatgpt.com