Business Transition Loan Default Rates: ESOP Loans: < 0.5%, Private Equity: 19.4%
We recently discussed a Fourth Quarter Uptick in ESOP Transactions and how Section 1042 Sales to an ESOP will likely become more attractive with the upcoming Increase in Capital Gains Rates. Giving Employees a Share is a Wall Street Journal/Smart Money article that discusses ESOPs as a business transition alternative, especially given the large decline in IPOs and lack of private equity interest:
At a time when credit is tight and alternatives like selling to a private equity firm have dried up, owners of the smaller businesses who want to exit and move on are in a bind.
What are the options? One is putting off retirement in the hopes that a turnaround in the economy will bring buyers back. However, others who don't want to -- or can't wait -- are increasingly looking for alternative strategies. One approach that's coming back into vogue is the ESOP, or employee stock-ownership plan, a defined contribution benefit plan that allows employers to sell all or part of their companies' ownership shares to employees. First popularized in the 1970s, ESOPs were created as a way to reduce workplace tensions and increase corporate performance.
It explores the financing issues, noting that the ESOP loan default rate is less than half a percent:
Landing financing is necessary for most ESOPs. (ESOPs financed by sellers don't involve banks at all.) And while doing so may be rough for companies with spotty credit histories, these entities are often seen as lower risk bets for banks. "Some banks look favorably on ESOPs because their default record is extremely low," says Corey Rosen, the executive director of the National Center for Employee Ownership, a nonprofit research group in Oakland, Calif.
In fact, the default rate for ESOPs clocked in at less than half of a percent, according to a study conducted by the NCEO last year. By contrast, private equity-owned companies logged a 19.4% default rate between January 2008 and September 2009, according to a Moody's study of 186 private-equity owned companies. Companies not involved in private-equity transactions, defaulted at a rate of roughly 18.6% over the same period, said Moody's.
Depending on the seller, using seller financing for part or all of a transaction can be an attractive alternative.
The article also explores some of the tax benefits to the seller and how an ownership culture will help grow the company.
The article also shares seven steps to creating an ESOP:
Is an ESOP right for you?
Make sure everyone's on board.
Conduct a feasibility study.
Get an appraisal.
Work up an agreement.
Support the ESOP.