A custom solution for a family-owned business
The owners of a successful manufacturing business in West Michigan were struggling to develop a plan for the future. For the second-generation sibling owners, the clock was ticking to find a succession plan that fit them, their families and the company. One third-generation family member has been a key person for the company but did not intend to purchase the business and become the sole owner. As time passed, the need to create a plan became more important because key customers were asking about business succession. They hesitated to renew large long-term contracts with the company’s future in question.
Attorney Dee Dee Fuller and I have been working with this company for many years and led the owners of this C corporation in the process of exploring possible succession plans. Here are the goals the owners discussed with us.
Goals of the owners
Keep the business in their West Michigan community
Keep the business closely held, rather than selling to one of the large competitors
Bring key employees into the inner circle and further develop their management team
Improve employee retention overall
Energize and further engage their workforce
Empower employees to think and act as owners and make decisions which benefit the company, as well as themselves
Provide an opportunity for employees to build wealth toward their own retirement
Involve key employees in high-level business plans and share financial information with employees while maintaining confidentiality
Grow the company
Increase the value of the company
Eventually retire and sell their shares to the other shareholders
With these goals identified, it seemed like a traditional employee stock ownership plan (ESOP) would be a great solution. We modeled an ESOP plan and discussed how it could work with the owners. But after working through the details, it was concluded an ESOP did not work well in this case, so other succession plan structures were considered.
The custom solution that we ultimately developed for this family business was a combination of a key employee share plan (KESP) and an employee share purchase plan (ESPP).
We first established the KESP. The owners select key employees each year and award them shares of the company. The KESP shares are limited to a relatively small number, with the objective to stop awarding shares to key employees within a fixed number of years, at which time, the family owners will be close to retiring.
Each award of shares vests over five years and is taxed as compensation to the respective employee. These shares have limited voting rights initially but will eventually have full voting rights. Key employees benefit from this plan by 1) doing the right things and being awarded more shares; 2) sticking around for the shares to vest; and 3) increasing the value of the company so that the shares increase in value.
When a key employee’s employment with the company terminates, the company will redeem the vested portion of their shares. The purchase price will be adjusted downward if their employment was terminated for a reason other than retirement, death or disability.
The current family owners sincerely expect the key employees will ultimately take over the management and ownership of the company and that the company will continue to grow and thrive after they retire.
In an attempt to provide opportunities for every employee and not just the key employees, the owners also established an ESPP. With this plan, all nonseasonal company employees are provided an opportunity to acquire company shares each year at a discount. The company will buy back the shares upon the employee’s termination of employment. After an employee works for the company for a certain number of years, then the company’s share purchase price is not discounted. These employees benefit from the ESPP by 1) purchasing more shares at a discount; 2) sticking around; and 3) helping the company increase in value by doing the right things.
The current family owners hope that by investing in the ESPP shares, their employees will establish greater loyalty to the company and its management team, use their best efforts to promote the company growth and development and save for their own retirement.
Even the best-designed stock plans will not work well unless the company owners and management team make changes to support the implementation. In this case, lines of communication are being opened up, additional management team meetings are being held and more training is available on leadership and other workplace soft skills.
During a recent key employee meeting when more shares were awarded, I remember hearing the team members state they felt honored and were proud to be selected to receive the award of shares and to lead this company in the future.
The plans are working. Here are some of the results we have seen in just two years.
All the new shareholders have stayed with the company, so far.
The key employees and many of the other employees appear to be more engaged.
In this past fiscal year, the company’s sales, profits and other key financial indicators are the best in company history.
The value of the business has increased.
The share value has increased by more than the value of the shares given away in the KESP and the value of the discount to the ESSP shares.
The family owners are very pleased they have been able to offer such an opportunity to their employees and are very optimistic their succession plan will be a success.
Long-term customers are comfortable and expect the company to be around long after the family owners retire.
Dee Dee and I have enjoyed the journey with this family and look forward to assisting the company owners (old and new) through their succession plan.
Peggy Murphy is CPA, CGMA, shareholder at Hungerford Nichols CPAs and Advisors.