NOTE: The changes that the Main Street Employee Ownership Act made to the Small Business Administration’s lending rules for ESOP loans to fund transactions went into effect April 1, 2019. The updated information is here.
Passage Of The Bill
Inside the recently signed $717 billion, Fiscal Year 2019 John McCain National Defense Authorization Act is a small provision that has nothing to do with national defense but a lot to do with a big opportunity for small businesses and lenders.
Originally proposed as the Main Street Employee Ownership Act (MSEOA), the new law makes it easier for small businesses to access Small Business Administration (SBA) 7(a) loans of up to $5 million to finance an Employee Stock Ownership Plan (additional financing can be combined with the SBA loan). Business owners who previously gave up on the idea of an SBA-guaranteed ESOP loan to fund the transaction because of the restrictive rules and cumbersome process may want to take a fresh look.
What Does This Mean?
In Terms Of SBA-Guaranteed ESOP Loans Versus Conventional Loans
The SBA does not actually make loans. What it does is set guidelines for loans made by partnering lenders, while the federal government guarantees the loans. That lowers the risk for lenders, making capital more accessible. The result is that an SBA loan may offer lower equity requirements, a better interest rate and a longer term than a conventional loan all for a comparable loan fee to a conventional loan. And once the new rules go into effect, the loan process will be managed directly by the bank instead of the SBA, streamlining the process. SBA-backed loans will also now be available to the company, not just to the ESOP and the proceeds of the loan can be used to fund transaction costs, not just the purchase price.
For A Small Business Looking For A Succession Plan
For succession planning, and to fund the purchase and sale of part or all of an owner’s interest in a company, an ESOP can offer excellent flexibility and deliver motivating tax advantages, including:
- Owner(s) having the option to sell to the ESOP partially, or in stages over a period of years so they can gradually ease out of the company.
- The company being able to fund the transaction entirely with pre-tax dollars.
- The cost of ESOP transactions being most often much lower than a third-party acquisition by a private company.
For A Small Business Focused On Growth And Employee Retention
In 2017, the National Center for Employee Ownership (NCEO) published “Building A Better American Economy.” It cited the following news and statistics:
- Of the 258 companies on Inc. Magazine’s Best Places To Work List, 36% offer some form of profit sharing.
- Employees at ESOP companies earn 5% to 12% more in median wages than employees in similar non-ESOP companies.
- ESOP participants have 2.2 times as much in their retirement plans as employees in non-ESOP companies.
To A Small Business Planning A Third-Party Sale In The Future
In the same publication, the NCEO reported that ESOPs have been shown to boost sales by more than 2% annually compared to comparable non-ESOP companies. Higher earnings plus a stable workforce almost inevitably enhances a third-party sale.