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.