How the rise in partial ESOPs could present a new opportunity for Private Equity firms

February 24, 2023

Companies with Employee Stock Ownership Plans (ESOPs) have typically been overlooked by Private Equity firms due to their perceived 100% employee-owned structure. However, in recent years, companies have been using more partial ESOPs. Could this be the turn of the tide for PE firms to consider these companies alongside the benefits that an ESOP provides?

ESOPs pass business ownership onto their employees, allowing them to reap the rewards of their labour, leading to greater productivity and employee satisfaction. Furthermore, ESOPs come with attractive tax benefits.

So why have they been overlooked, and why are companies using partial ESOPs? Typically, ESOPs have been perceived as a means of transferring full ownership to employees which would leave no room for an external investor to buy in. This level of ESOP would usually be used to transfer ownership without the need to find a buyer. In recent years, due to various unforeseen circumstances including the COVID pandemic, Ukrainian war and cost of living crisis, many entrepreneurs have been looking to diversify their assets. By using a partial ESOP, business owners are able to reduce their level of risk in one asset by giving up a part of their shareholding, hence the popularity in times of economic instability.

What part can PE firms play in partial ESOP businesses? There are a number of opportunities. For example, they could provide growth capital to a business which has adopted an ESOP to create a workforce more focused on and motivated to deliver added value. This would provide the opportunity for the business to grow at a faster rate, aided by the ownership-incentivised employees performing at a greater level of productivity. Furthermore, with the current level of competition for talent and employee retention, a partial ESOP business could be a good way to increase long-term retention – particularly relevant for impact investment funds.

In conclusion, PE firms could benefit greatly from investing in ESOP companies due to the greater productivity and retention that comes with employees having a stake in the result of their work, and the added value it is likely to generate.

MM&K has recently released the 2022 version of the Private Equity and Venture Capital Report, detailing all remuneration elements and trends throughout the year. For more information, contact Margarita Skripina.

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