ESOP Helps Family Keep Company in Familiar Hands By JACQUELINE FOX Staff Reporter Sheila Xitco and her husband, Mark made the decision roughly four years ago to retire, which meant selling their family owned business, Santa Clarita-based M W Sausse & Co., Inc. But the company, which manufactures vibration isolation equipment for industrial air conditioning units, was launched by Sheila’s parents in the 1960s. That meant emotional ties to the business ran deep and there were no other family members in line to take over. In addition, many of their 50 employees have invested 20 years or more at the company and selling off Sausse to an outsider, they felt, would almost certainly have come at the expense of jobs and quite possibly the death of the entire business. So instead of putting Sausse on the open market, the Xitcos, along with Sheila’s sister, Barbara Sausse, the company’s long-time controller, decided to offer the business to those they trusted most: their employees. In October of 2003 the three sold 100 percent of their share of the value of the company to five veteran employees through an Employee Stock Ownership Plan or ESOP. Xitco says the comfort of seeing her parent’s legacy shift into the hands of loyal and long-time employees as opposed to an outside interest, made the heartbreak of terminating the Sausse family ownership a little less painful. “This was a very difficult process for us to begin with” said Xitco, who served as general manager before the sale. “We needed to put together a plan for our retirement but we didn’t want outsiders to come in. So instead, we’ve turned the company over to a management team that has plans to expand the company, not shut it down. That, to us, represents a huge comfort. These are people we know and love and respect.” Setting up fund Here’s how it works: The sellers set up a tax-exempt ESOP trust fund, take out a loan and then put that money back into the fund, which the buyers will later use to purchase the business from the original owners. ESOP stocks are then allocated into tax-free accounts for each employee/shareholder based on payroll and subject to vesting and can be sold when an employee leaves or retires. In addition to keeping the company within known hands, the ESOP strategy also comes with other advantages. Because the Xitco’s and Sausse sold more than 30 percent of their stock in the company to their employees, they are allowed to defer paying taxes on the capital gains from the sale and can continue to defer those payments as long as they reinvest those proceeds in outside stocks or bonds or other approved funds. That’s not to say the process of setting up an ESOP is always cut and dry. In this case, the Xitcos established their ESOP three years ago and began contributing to it in order to self-finance most of the transaction because back in 2001 the economy was tanking, sales were down and getting a loan was proving next to impossible. “It’s very unusual that it took this long to complete their ESOP,” said Kyle Coltman, chief executive officer at San Francisco-based Menke & Associates Inc., which helped the company through the sale and will continue to administer the new company’s ESOP fund. “But obtaining an attractive loan package was an issue for them at the time and, although most ESOPs are financed through bank loans, this was not the most opportune time for them to do that so they had to piece the financing together in other ways.” ESOP checklist In most cases, says Coltman, an ESOP can be completed in less than three months. But before the wheels are set in motion, he says there’s a checklist he and most ESOP administrators prefer to run through in order to determine if the strategy is right for the business in question. “I typically look for three things,” Coltman said. “I want to know if they are profitable, because what good is a tax deferment (on the sale proceeds) if they aren’t? I also want to know if the seller has a realistic idea of what the company is worth and whether it’s worth enough to generate a profit after the sale. Finally, I ask about payroll, because the government allows the new ownership to take a tax deduction on employees’ contributions into an ESOP trust, but the key is that it’s limited to 25 percent of the payroll.” In addition, Coltman said he stresses the importance of fully evaluating the buyers’ qualifications, their long-term vision for the company and what, if any plans they have for carrying that vision forward, before approving an ESOP plan. “There’s no point in selling through an ESOP if you’re going to put the company into the hands of unqualified people,” said Coltman. Xitco’s buyout package calls for her to remain on the payroll as a salaried employee for possibly two more years. Mark will stay on another four to five years as an outside sales representative. Barbara is transitioning out of the business within the next few months. These long-term exit plans through ESOPs are common and can help sellers maximize their final buyout packages, said Coltman. But there are drawbacks, namely, making the transition from owner to employee and then working in that environment with limited authority to control the day-to-day operations. “I wouldn’t not do this again if it were to do all over again, I’m certain of that,” said Xitco. “But there are adjustments to be made every day and they aren’t easy. Having said that, this company is going to change and it’s going to have to grow, and perhaps more dynamically than Mark or my sister would ever have anticipated. But at least we know it’s not going to do so by getting rid of people or dissolving.” Employee Stock Ownership Plans Employee Stock Ownership Plans or ESOPs are one way to hand over a company in a comfortable way by keeping the firm in the hands of loyal and long-time employees, according to Kyle Coltman (photo), chief executive officer at Menke & Associates Inc. which helps companies through ESOPS. But there are some key points to consider before entering into this kind of a transaction. He recommends that before establishing an ESOP you should: -Have a realistic idea of your company’s value when you call an ESOP administrator and have all necessary documentation to back it up with. -Find out if your company can generate a profit after the sale. -Know who you are selling to and what the buyers’ (employees) long-term vision for the company is and if they are qualified to carry on with that vision once you let go. -Plan early if you think you may not have access to funding to repurchase your share of the company by setting up an ESOP trust and contributing to it regularly with profits and other resources. -Be prepared for the possibility of having to stay on the payroll for a while after the sale and adjusting to the transition from owner to employee.