The manufacturing industry has been a prominent presence in the employee stock ownership plan (ESOP) landscape in the U.S. since the 1980s. This presence has only strengthened over the years due to changing economic climates, globalization, and the need to maintain a competitive advantage. As of February 2025, data from the National Center for Employee Ownership (NCEO) shows that the manufacturing industry has the highest concentration of ESOPs among private companies.
Selling to an ESOP has long been popular among business owners in the manufacturing industry for several reasons. Known for its emphasis on innovation and workplace culture, this industry uniquely benefits from adopting an ESOP structure. Additionally, the tax benefits associated with ESOPs as a qualified retirement plan, along with the flexibility they offer to selling shareholders, make them an attractive exit strategy.
This article delves into these reasons and discusses how and why an ESOP can be an excellent fit for manufacturing companies.
Why Manufacturing Companies Consider ESOPs
Many successful manufacturing companies share several common traits: a commitment to innovation and product development, a skilled and dedicated workforce, effective financial management, and a strong sense of corporate responsibility. These traits can facilitate a smoother transition to an employee-owned model. Manufacturing is a critical component of the U.S. economy, and employee ownership can help address the retirement gap many U.S. workers face. Manufacturing and employee ownership can be an excellent fit and continued growth in ESOPs within the manufacturing sector is anticipated.
In today’s competitive job market, many business owners recognize the challenge of attracting and retaining talent. An ESOP can help address this issue by offering long-term retirement benefits that, if communicated effectively, can serve as a powerful retention tool. Manufacturing jobs can be demanding, often involving long hours and shift work. The limited potential for career development in many roles can lead to burnout and workers choosing to leave for better pay or different opportunities. By fostering employee engagement and culture and offering competitive salaries, robust retirement benefits, and improved work-life balance, many companies can alleviate turnover in the manufacturing industry.
An ESOP can engage a workforce by encouraging employees to take more ownership of their work, understanding that their efforts can directly contribute to driving value and increasing their ESOP account balances. This sense of ownership not only motivates employees but also aligns their interests with the company's success, fostering a culture of collaboration and innovation. Additionally, ESOPs can enhance a company's reputation as an employer of choice, attracting top talent who seek more than just a job, but a meaningful stake in the company's future.
ESOP Basics
An ESOP is a versatile corporate finance tool that can benefit selling shareholders, the company, and its employees. For selling shareholders, an ESOP is a flexible exit strategy, allowing them to sell their shares at fair market value without relinquishing operational control to an external buyer whose culture or values may not align with the company's. This option can also offer tax advantages, such as tax deferral under IRC Section 1042 on the sale of C corporation stock to an ESOP, enhancing the after-tax benefits of the sale. For more information on ESOP basics, see our ESOP FAQs page.
Manufacturing Industry Considerations
When considering an ESOP in the manufacturing sector, specific concerns should be addressed during the feasibility phase. Identifying potential roadblocks or pitfalls early on in the transaction helps to ensure a smooth process and avoid any last-minute delays.
Valuation: Large CapEx and PPE
Manufacturing companies often have substantial capital expenditures (CapEx) and significant property, plant, and equipment (PPE), which play a crucial role in determining the company’s valuation. The valuation must accurately reflect the assets’ current value and future depreciation, which are critical to the company's operations. Additionally, ongoing CapEx to maintain and upgrade equipment must be considered, as they impact cash flow and financial health. A thorough and precise valuation assessment is essential so the ESOP transaction is fair and equitable for all parties involved.
Financing
Manufacturing companies typically have significant assets, making them attractive candidates for third-party financing. Leveraging these assets provides selling shareholders flexibility in structuring the transaction. These assets can offset the perceived risks that banks or other financing sources may have regarding cyclicality, industry lifespan, or customer concentration. Developing a solid financial strategy and understanding the financing landscape is crucial for a successful ESOP implementation.
Communication
For an ESOP in the manufacturing sector to be successful, employees must understand the benefits of long-term retirement planning. Educating employees about how the ESOP contributes to their retirement security can enhance engagement and commitment to the company's success. This involves clear communication about how the ESOP works, the value of employees’ shares, and potential growth over time. By fostering a culture of financial literacy and ownership, companies can ensure employees are motivated to contribute to long-term goals and feel invested in the company's future.
Environmental and Safety Record
Manufacturing companies must adhere to stringent environmental and safety regulations, which can impact both the company valuation and the ability to close the transaction in a timely manner. A strong environmental and safety record is essential to avoid potential liabilities that could affect the company's valuation and potential obligations for the selling shareholders post-close. Conducting Phase I and Phase II environmental assessments can help identify existing or potential issues. Compliance with OSHA and ANSI regulations will be an important part of the diligence process conducted by the buyer.
Stable Cash Flows – Cyclicality and Changing Industry
The manufacturing industry often experiences cyclical market conditions and evolving industry dynamics, affecting cash flow stability. When considering an ESOP, it's important to evaluate how these factors might impact financial performance. Downside modeling is essential to understand how much revenue and EBITDA can decrease while remaining in compliance with bank covenants or ensuring the ability to pay seller note principal and interest. Developing strategies to manage cyclicality, such as diversifying product lines or entering new markets, can help stabilize cash flows. A thorough analysis of industry trends and potential disruptions is important to verify the ESOP is sustainable and the company can meet its financial obligations to employee-owners.
Current Regulatory Environment
The current tax and regulatory environment, including changes to tariffs and trade policies, can significantly impact the manufacturing industry's outlook and the valuation of a company considering an ESOP. Tariffs can affect the cost of raw materials and the competitiveness of products in global markets, influencing profitability and cash flow. Understanding the potential impact of these factors on a company’s financial health and future prospects is crucial for accurate valuation and long-term financial success. Companies must stay informed about changes in tax and regulatory policies to assess their implications for the ESOP and develop strategies that mitigate risks and capitalize on opportunities.
ESOP Success Story: Manufacturing Industry
A specialty manufacturer founded more than 60 years ago and headquartered in the Midwest manufactures and distributes safety products globally. The second generation owner, seeking to fully exit the business, was introduced to BDO Capital’s ESOP Advisory Services team by his accountant. After evaluating all feasible options, the owner chose to proceed with a 100% sale of the S corporation to an ESOP, which he deemed the best path forward for himself and the company. Initially, the firm was incorporated as a C corporation with a non-calendar fiscal year-end. The BDO Capital team worked with the company and their accounting firm to transition the business to an S corporation and moved to a calendar fiscal year-end. Additionally, as part of the transaction, the BDO Capital team worked with the company’s incumbent bank to secure a substantial term loan to finance a portion of the transaction.
The company employed international staff who would face adverse tax consequences if they participated in the ESOP. To address this issue, a phantom stock plan was created that provided the international employees with equivalent economic benefits without the adverse tax consequences. This approach allowed for consistent employee ownership-related communication and messaging for all employees worldwide.
With extensive experience in advising and structuring numerous ESOP transactions for manufacturing firms nationwide, BDO Capital Advisors was able to navigate various challenges that could have delayed or jeopardized the transaction. Furthermore, BDO Capital Advisors structured the ESOP to deliver significant benefits while also working towards sustainability for future generations of employee-owners at the company.
Is an ESOP Right for Your Manufacturing Business?
For manufacturing business owners considering a sale to an ESOP, it is crucial to consult with an ESOP advisor who has the expertise to navigate the complex regulatory and tax challenges specific to the manufacturing sector.
BDO Capital Advisors is well-equipped to guide you through each phase of an ESOP transaction. By working closely with professionals from BDO USA, we can explain the common tax implications associated with various ESOP scenarios in the manufacturing industry.
If you are considering an ESOP as part of your business transition strategy, now is the time to act. Contact BDO Capital Advisors to schedule a consultation and explore how an ESOP can benefit your business and align with your long-term goals.
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