The ESOP Exit
An ESOP exit, in the simplest sense, is a sale of a company to that company’s employees. The mechanics of how this all works, as well as how it all operates after the fact, are outlined below, and for the sake of simplicity an ESOP exit is a true sale of one business to another, with the typical outcomes expected (liquidity, new ownership, etc).
Now, a more detailed explanation of this is as follows: A sale of the company to its employees is a classic business acquisition transaction where there are the predictable roles of both buyer and seller. The buyer is a company’s employees, and the seller (or sellers) is any existing equity holder in the company. Each side is independently represented via legal counsel, and there is a standard negotiation of price and terms. Once all parties agree, the transaction is executed and the company is sold.
There is more information regarding the specifics of an ESOP transaction here, and for the purposes of this article, we are going to focus on the exit itself rather than the transaction.
Exit is defined as “going out of or leaving a place”, and a common misconception with an ESOP is that you can actually exit. It should also be explained that goals of selling shareholders often differ. Some may want to exit, some may want to stay on, and an ESOP supports all of these options well.
For shareholders who want to exit, the ESOP offers to ability to create a position to backfill yourself. The process looks like this:
1. Plan to take a full exit, and be sure to include the value of your salary add back, which is usually 4-6X your annual salary.
2. Be sure to also add back anything else that is in your overall comp package, which includes any benefits and owner discretionary perks you are receiving. These can also be added back at a 4-6X multiple, depending on your valuation multiple.
3. Create an enticing equity position in the company as a member of the management team, and include participation in the management incentive plan. If it makes sense to do this, break your role up and offer two established team members roles on the management team, as well as participation in the management stock option plan (called a management incentive plan).
4. Present your teamers with the offer, and explain they have now become partners in the company. Their stock percentage is likely now between 6% and 9%, and their compensation has some very compelling layers. See here for more information about creating partner roles and cementing key management team members in the management plan.
5. Lastly, expect there to be a transition period. You will likely want to stay on board for a period of time to transition your role(s).
At Techwood, I was able to transition my role of CEO and lead sales person to two people. I offered a promotion to our COO to my role of CEO, which included a compensation improvement and a strong position in the management incentive plan, and then I recruited a colleague away from a tenured position as a lead sales director of an existing solutions firm, which is much easier to do when able to offer a four-level compensation package (salary, bonus, equity, and management stock options).
Once I had supported an effective transition to these members, I was able to reduce my role to one of board member (in my case, chairman of the board).