This new book, which combines Selling to an ESOP with chapters on financing and legal issues from Leveraged ESOPs and Employee Buyouts to form a new book replacing both, is designed to educate owners, managers, and advisors of closely held businesses. It describes how ESOPs work, their basic rules, valuation in the ESOP context, evaluating feasibility, M&A issues, bank and seller financing, using warrants, alternative financing sources, and the tax-deferred Section 1042 rollover for selling owners. Every chapter has been updated for the new edition. Armed with this book, readers will be able to make a more informed decision about selling to an ESOP and financing the transaction.

Product Details

Perfect-bound book, 235 pages
9 x 6 inches
12th (October 2023)
In stock

Table of Contents

1. A Primer on ESOPs for Closely Held Companies
2. Understanding ESOP Valuation
3. ESOP Feasibility
4. Section 1042 and the Tax-Deferred ESOP “Rollover"
5. Investing After You Sell Your Business to an ESOP
6. Using ESOPs in Mergers and Acquisitions
7. Bank and Seller Financing for ESOP Transactions
8. Warrants in ESOP Transactions
9. Alternative Financing Sources in ESOP Transactions
10. Alternatives to Selling to an ESOP
About the Authors
About the NCEO


From Chapter 1, "Should You Sell to an ESOP?"

Beyond Financial Benefits for Sellers

  • Timing: An ESOP allows sellers to sell at their own pace, retaining whatever role they prefer in the company. That may mean sellers stay on as managers, consultants, and/or board members indefinitely, or they may gradually withdraw to a more limited role. Other owners leave day-to-day management immediately after selling shares to an ESOP. While it is possible for other transaction structures to allow flexible timing, it is not typical and generally is the subject of difficult negotiations.
  • If there are multiple owners, the ESOP can buy shares only from those who want to sell: When there is more than one owner, one may be ready to sell and, perhaps, retire, while others may not be ready. Outside buyers do not want partners in most cases, so with an outside buyer, everyone has to sell.
  • The company will retain its identity: Many owners have worked hard and long to build a good name for their company. Seeing it vanish into another company and, in some cases, move outside the community can be painful.
  • Even after you sell, you can stay involved: After selling to an ESOP, many former owners retain a board seat or some other involvement with the company for some period.
  • Employees who helped build the company now own it: Many owners have a strong sense of loyalty to their employees and hate the idea of their becoming employees of another company, where they might not be treated well and often would be asked to leave. That is especially true at the senior level.
  • With the right culture, ESOPs improve corporate performance: ESOP companies with a high-involvement work culture where employees regularly participate in decisions about how their work is done and that share a variety of company performance metrics with employees perform substantially better than non-ESOP companies. For a detailed look at how this works, see my book Beyond Engagement: How to Make Your Business an Idea Factory.
  • ESOPs can add substantially to employee retirement security and reduce employee turnover: ESOP participants end up with about 2.2 times the retirement assets as employees in 401(k) plans and have significantly lower turnover rates.

From Chapter 3, "ESOP Feasibility"

Transaction Design Characteristics

  1. Corporate status? An ESOP may be adopted only by a C corporation or an S corporation. (There is one private letter ruling (PLR) for an LLC, with very specific facts.) If the company is an LLC, careful consideration must be given, based on tax and legal advice, as to whether to convert to a C or S corporation.
  2. What is the target percentage of stock for the ESOP to acquire?  This is sometimes driven by the desire of selling shareholders in closely held C corporations to qualify for the Section 1042 “tax-free” rollover, which requires that the ESOP own a minimum of 30% of the outstanding stock of the corporation on a fully diluted basis after the acquisition. Determining which shareholders qualify for the Code Section 1042 tax-deferred rollover, as well as the need to buy out specific shareholders, also may affect the target percentage to be acquired by the ESOP.
  3. When will the stock be acquired? ESOPs can “warehouse” cash contributions for a relatively short period of time before the ESOP acquires stock. However, loan proceeds must be used immediately by the ESOP to acquire stock. Many ESOPs purchase shares in two or three stages over a period of five to ten years or more.

From Chapter 5, "Investing After You Sell Your Business to an ESOP"

Aversion to paying tax is powerful, so the idea of buying and holding a diversified portfolio of stocks and bonds designated as QRP may be very appealing. After tailoring the asset allocation to meet their risk profile, owners who invest in QRP typically want to sell as little as possible in order to defer tax indefinitely.

But applying this strategy to the entire sale proceeds is risky. It means maintaining a static portfolio as the market evolves. And while the basket of QRP securities purchased may not mirror the index, let’s use the S&P 500 as representative of a broadly diversified portfolio. In 1958, the average company inside the S&P 500 Index could expect to remain there for 61 years. In 2023, the average tenure is likely to dip below 20 years. Purchasing a portfolio based on a market index inherently favors stocks that have performed well in the past—but they may not perform well in the future, as table 5-2 shows. These days, a long-term investor must be able to adapt to the accelerating pace of change in today’s world.

Buy-and-hold bond strategies are also risky. When interest rates rise, prices of long-duration bonds decline significantly. In 2022, when the Federal Reserve raised interest rates seven times, totaling 4.25%, the S&P U.S. Treasury Bond 20+ Year Index declined over 30%. While buy-and-hold investors may recover these “paper” losses over time, they are likely to be disappointed if they need to sell a bond unexpectedly.

From Chapter 8, "Warrants in ESOP Transactions"

As indicated above, the warrant strike price must be at least 90% of the fair market value of the underlying stock that is subject to the option on the date of issuance.

The fair market value of the underlying shares may be the transaction value or post-transaction value. Either value can be used; however, the selection of the valuation date has a significant impact on how many warrants are issued—the higher the strike price, the more warrants that must be issued to achieve the targeted return. With a lower strike price, fewer warrants need to be issued to achieve the targeted return.

From Chapter 10, "Alternatives to Selling to an ESOP"

A more common option is a sale to another company, often a competitor. Many business owners believe they can get a substantial premium in doing so. It is not clear just how realistic this is for ESOP candidates. The NCEO surveyed ESOP advisors to ask how many of their clients could have sold for a 20% premium, a number that would at least significantly overcome the tax advantages possible in an ESOP where the seller defers tax on the gain. About half the advisors said only 2% to 5%; the other half said 25% to 40%. The bifurcation may reflect their roles—lawyers were on the low end, while investment bankers, who are often hired by sellers who think they can get a significant premium, are on the high end. Either way, only a minority of sellers receive a large premium. Moreover, this premium often comes with contingencies, terms, conditions, representations, warrants, employment agreements, and other requirements that may make the sale price less than what it seems. For instance, the nominal offer may be for a 30% premium, but a portion of that may be contingent on meeting future sales targets. ESOPs do not have these requirements.