Retirement planning or planning to sell your business can be a tricky and sensitive subject to navigate.
Independently owned businesses, and specifically collision repair shops, are more often than not a physical embodiment of the years of hard work an owner and his or her team have put into developing and running it.
Matt DiFrancesco, a certified financial and exit planner for High Lift Financial, specializes in financial guidance for the collision industry. He says he often sees a particular scenario play out when helping shop owners plan for succession: A shop owner is looking to sell and retire, but he or she doesn't have any family or employees who want to purchase the business. And they’re concerned about selling to a third party and losing the culture they've developed.
Oftentimes when this happens, if the circumstances are right, DiFrancesco says an employee stock ownership plan (ESOP) could be a good fit.
“ESOPs are great for owners who want to stay in the business for some period of time and maintain some level of control but don't necessarily want to sell to a third party,” DiFrancesco says. “They can be a great option for an owner if they've developed a nice culture and consider themselves a nice community asset.”
ESOPs aren’t feasible for every shop, but DiFrancesco says if you’re trying to formulate a succession plan, they’re definitely worth looking into.
What is an ESOP?
Employee stock ownership plans are essentially qualified retirement plans that are governed by the IRS and the Department of Labor. An owner sells his or her stock — it can be any amount, but DiFrancesco says typically owners should sell at least 30 percent — to a trust in exchange for cash. The trust then distributes those stocks to vested employees. Once those employees retire, they sell their stocks back to the trust in exchange for pre-tax retirement funds.
“It's an additional benefit, and typically the way I see them work is in conjunction with a 401(k) plan. They'll have the 401(k) they contribute to, and then they'll have this extra bucket from the ESOP,” DiFrancesco says. “The beauty of it is that, when they sell the shares and get the lump sum, it's tax-deferred until they start taking money out of it. They don't incur any tax through accumulating the shares.”
DiFrancesco says if a shop can feasibly implement an ESOP, it can be a win-win for both an owner and their employees, especially if an owner isn’t quite ready for retirement.
“If you're an owner who doesn't know what your transition plan is and has the cash flow to be able to support it, an ESOP can maintain control of the company and the culture it brings,” he says. “It gives employees the opportunity to have ownership in the company while the owner can maintain some liquidity.”
ESOPs are also best utilized when given time to develop. Establishing one at least five years before you plan to retire or otherwise sell your business will give the plan time to develop and allow both you and your employees to reap the benefits.
Because of that, DiFrancesco says it’s never too early to start planning.
“You should be planning your succession from the moment you start operations. The earlier you start, the better,” he says. “Typically, a lot of the clients I get are looking for immediate solutions -- that's too late to start an ESOP.”
When does an ESOP make sense?
Though an ESOP may sound tempting, DiFrancesco warns that they’re not realistic for all shops.
“One of the drawbacks is that they can be very expensive to implement. It’s pretty much for larger operations,” DiFrancesco says. “There are a lot of regulations around them, too, so you have to hire a third-party administrator to be able to administer those. The cost can be high, which is why most times it doesn't make sense for smaller shops.”
The total upfront cost will vary depending on how much of a company the owner decides to sell, but whenever DiFrancesco is helping a shop plan for an ESOP, he says he looks for them to have a minimum of $2 million in free cash or earnings before interest, taxes, depreciation and amortization (EBITDA) for the plan to make sense.
Establishing an ESOP could cost anywhere from $50,000 to $300,000. Your shop will also need to hire an ESOP administrator to handle all IRS and labor department regulations, which will add recurring administrative costs. Because of that, DiFrancesco says the operations he sees being the most successful with ESOPs are MSOs with multiple locations doing well.
“Your shops are typically your largest asset, and that needs to fit into your plan,” he says. “If we can build value in those locations, that's going to net them more in the endgame, plus it's going to increase cash flow, which then gives them more options from an exit standpoint.”
Every shop owner should at least get a handle on the value of his or her business to see if an ESOP makes sense or if something else does. In order to do that, DiFrancesco says the first thing owners should do is hire some kind of exit planner who can help guide them through their goals. Those planners would be able to evaluate if an ESOP makes sense to even investigate.
Once a planner helps decide if an ESOP is worth pursuing, bringing in an ESOP expert to conduct a feasibility study is the next step.
“You need to bring in experts. As we figure out an overall plan for succession, those experts become part of the team,” DiFrancesco says. “You need to figure out what your long-term goals are. That's the starting point in all of it.”
Even if an ESOP isn’t the best fit, there are different stock bonus programs or other benefits that may work better for your shop, and a succession planner can help identify those.
If an ESOP does fit your shop, your succession plan, and your overall goals, however, DiFrancesco says it can be a game changer for you and your employes.
“It gives the employee a vested interest. You're developing an entrepreneurial mindset among all of them, and they know their performance is going to raise the value of that stock, which in turn will give them a greater return in the end,” DiFrancesco says. “Any time you can give employees some kind of ownership, it motivates them. It's their baby now, too.”
