Did You Know You Can Sell Your Cannabis Business to Your Employees? Here’s Why You Should Consider It
By Darren Gleeman, Managing Partner, MBO Ventures
As a business owner, you want your employees to remain loyal, care about the company, and do their best work to bolster the success of the business. But what about the day when you decide to exit the business yourself? Do you trust that your employees will stick around under new ownership? How will you guarantee your employees are getting the same support, if not more than what you gave them? Will your company prevail?
Here’s an idea: you can sell your business to your employees via an Employee Stock Ownership Plan (ESOP). This is an example of a creative exit strategy that will benefit both you and your workforce. In this article, I’ll detail the financial and cultural benefits of selling your cannabis business to your employees.
What is an ESOP?
First, I’d like to clarify what an ESOP is and how it works. Just like you can sell your company to a private equity firm, an ESOP is another way for a company to sell itself. You can either sell your company to a strategic buyer, or you can sell your business to your employees in an ESOP structure.
You might be wondering, how can my employees afford to buy the company when they don’t have the capital to do so? Short answer: It costs the employees nothing. It is a gift from the IRS.
ESOPs, similar to private equity, are funded by debt in the form of a bank loan, or a seller note. This debt is subsidized by the government. And it is a big subsidy. The government allows the company to take a full deduction of the purchase price of the company. I.e. If you sell the firm to the employees for $25 Million dollars, the company can take a tax deduction of $25 Million Dollars.
Why Sell to Your Employees?
Sure, you could sell your business to your employees out of the kindness of your heart—these workers are people you probably see every day and have grown fond of. But why would anyone choose to sell their business to their employees when you could also have juicy offers coming in from, let’s say, a private equity firm?
Well, the government actually set forth a program where they’ve incentivized companies to sell to the employees by giving them a multitude of tax benefits. Let’s review a few of these advantages.
1. Capital Gains Taxes are Deferred… Forever
When you sell your company to a private equity lender, you have to pay capital gains tax. When you sell your business to your employees in an ESOP structure, the government allows you to defer those capital gains. Essentially, if you structure your ESOP correctly, these taxes are deferred forever.
2. ESOPs Pay Zero Federal and State Taxes
If you sell 100% of your company to an ESOP, the company itself pays no federal or state income tax. In many cases, this enables businesses to double or even triple their current cash flow.
3. IRC Tax Code Section 280E Becomes Irrelevant
Internal Revenue Code Section 280E states that cannabis companies are taxed differently than any other industry in the United States. For other industries, companies get to take deductions on their taxes. Cannabis businesses, on the other hand, are not allowed to take any deductions at all. When you pay your company’s income tax, you can’t deduct your salary, rent, marketing, legal fees, or anything else. 280E makes doing business in cannabis extremely difficult.
But cannabis businesses that are structured as an ESOP don’t need to worry about 280E at all. Why? Because they already pay zero taxes. If you pay zero taxes, why would it matter that you can’t take a deduction? It simply doesn’t.
4. Employee Retention Remains Strong
When a company transitions to an ESOP, the employees are no longer employees, they’re owners. Typically, once they realize that change in status, they will work harder. They’ll be more productive and less likely to quit. So automatically, the company’s employee retention rate skyrockets. In fact, employee turnover in an ESOP organization is about 10.8%. Yet, the turnover rate in a non-ESOP is 27.1%.
5. You’ll Receive Warrants to Buy Back Your Company, If You Choose to Do So
Another advantage with an ESOP is that the company owners, who are selling the business to their employees, can receive warrants. A warrant is ultimately an option to buy back some of the company, so you can purchase company stock at a later date at a very low price.
Let’s use an example. Let’s say an owner sells her company to an ESOP for $10 Million, and gets warrants to buy back 15% of the company, at any time in the future. The predetermined price to buy back 15% of the company would be about $500,000.
And the timeframe to buy back this 15% would be ANY TIME in the next 14 – 20 years.
The benefits of transitioning your cannabis company to an ESOP are evident. The question isn’t necessarily: what would happen if you sold your company to your employees? Instead, the real question is, what would happen to your company if you don’t?
About Darren Gleeman
Darren Gleeman is the Managing Partner of MBO Ventures, the cannabis industry’s premier ESOP investment bank. The firm provides ESOP (Employee Stock Ownership Plan) expertise and will also invest its capital alongside company owners and/or management teams. In 2023, Darren received a patent pending for his ESOP methodology used in completing the cannabis industry’s first ESOP, alleviating tax implications of 280E for a plant-touching multi-state operator, Theory Wellness. Darren was also awarded the Green Market Report 2024 Top Financial Advisor Award.
Darren’s beginning at Wharton Business School brought him to understand the value of quantitative modeling and the scientific method. From there, he founded a hedge fund that took the human element out of trading. He transitioned the company into one of the first high frequency trading platforms in the world, trading over 1% of all US Equities every day.
Darren went on to become the Founder of e-Coupons, Managing Partner of both GMD Trading, and GB Trading. In addition to being highly sought after for his ESOP knowledge and financial acumen, he is a prolific angel investor with early investments in companies such as Screaming Media (NASDAQ:SCRM), Blackboard (NASDAQ:BBBB), Social Radar, and his latest investments in Class.com and Accelerant Manufacturing.
