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Selling Your Business to an ESOP

Formerly titled Selling to an ESOP

(Print Version)

9th Edition

by By Keith J. Apton, Michael A. Coffey, Ronald J. Gilbert, Joseph V. Rafferty, Loren Rodgers, Corey Rosen, Kenneth E. Serwinski, and Brian B. Snarr

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Myths and misconceptions prevent many owners of closely held businesses from considering selling their companies through an employee stock ownership plan (ESOP). For many such owners, ESOPs have advantages in terms of tax, financial, and intangible issues that no other transaction method can offer. This book (titled Selling to an ESOP in previous editions and now revamped to focus on the decision whether to sell to an ESOP) is designed to educate owners, managers, and advisors of closely held businesses on selling to an ESOP. It describes how ESOPs work and what the basic rules are; alternative sale strategies and how they compare to an ESOP sale; financing and feasibility; and the tax-deferred Section 1042 rollover, which has benefited many selling owners over the years. Armed with this book, you will be able to make a more informed decision about selling to an ESOP.

Publication Details

Format: Perfect-bound book, 162 pages
Dimensions: 6 x 9 inches
Edition: 9th (April 2012)
Status: In stock


1. An Introduction to ESOPs
2. Should You Sell to an ESOP?
3. Understanding ESOP Valuation
4. Financing the Leveraged ESOP
5. ESOP Feasibility
6. The Section 1042 Rollover
7. The Prohibited Allocation Rule Under Section 1042
About the Authors
About the NCEO


From Chapter 2, "Should You Sell to an ESOP?"

The management buyout example assumes the company would be worth $10 million after 10 years. The ESOP example assumes somewhat slower growth for the ESOP-owned company because of the debt, so that after 10 years the company would be worth $8 million (in fact, this is almost certainly far too conservative because ESOP companies tend to grow faster than non-ESOP companies and will overcome the debt issue in several years, but we're being cautious here). Management would own 33% of that, worth $2.64 million, or about $533,280 each. In the management buyout case, they would net $300,000. In other words, the ESOP turns out to be a better deal for management, even with management owning less of the company. Moreover, the managers could roll their ESOP distributions into an IRA on a tax-deferred basis.

In some ESOP companies, management may also get some additional equity in the form of stock appreciation rights or phantom stock. Where this is done, it might add another few percentage points to the ownership of each manager, making the deal even better.

Table 2-1 summarizes this comparison. The assumptions here are meant to be realistic and modestly conservative. But every example is very different in terms of how many managers are involved, how the management buyout is set up, payroll differences, turnover differences, and what happens to the company after the buyout. The point is not that managers or sellers are always better off with an ESOP approach, but rather that the kind of calculation shown here should be made before making a decision.

As the next section of this chapter explores in more depth, it is common for the ESOP to own only part of the company, leaving flexibility for managers to purchase additional stock and/or receive additional equity as incentives. So the five managers here might buy 30% of the company, or they might acquire the rights to an additional 15% to 20% of the total equity value through stock appreciation rights, for instance, making the ESOP approach even more favorable to them.

From Chapter 6, "The Section 1042 Rollover"

After the rollover is taken, transactions in the replacement properties create taxation on the properties involved. Why not invest the rollover proceeds in a portfolio that is fixed in value and then borrow against the portfolio to produce manageable investments?

The Section 1042 active reinvestment strategy is achieved through the purchase of QRP in the form of high-grade corporately issued floating-rate notes (FRNs). The transaction is implemented by using leverage through the use of a monetization loan from a bank. This strategy provides the selling shareholder with the greatest amount of liquidity and flexibility pertaining to the use of proceeds from the sale of stock to the ESOP.

If the proceeds from the monetization loan and/or FRN are invested properly, this may result in the highest investment potential. It also provides the benefit of active "risk" management from the sales proceeds, along with the ability to unwind part of the portfolio later with proper tax harvesting, resulting in no tax consequences.

Typically, an FRN pays interest quarterly to offset almost all of the costs of the monetization loan. The income from the FRN is designed to reduce the "cost to carry" of the leveraged monetization loan. This allows the investor to realize increased flexibility to reinvest into an actively managed portfolio, real estate, other businesses, or any other investment. Most importantly, the investor can manage risk with no strings attached as to what he or she has to do with the proceeds.

The greatest benefit of the active strategy is the investment flexibility that it provides. Tax-free access to capital should provide greater returns and less risk than a buy-and-hold portfolio.

The disadvantages are the negative cost of carry associated with the loan, the use of leverage, and the credit quality of the underlining FRNs. With the proper structure, all of this can be managed appropriately.