May 29, 2019

Start Here: ESOP Transactions

ESOP transactions vary widely depending on factors such as the size of the company (which ranges from under 100 employees to over 100,000), the percentage of shares the ESOP will acquire (from less than 1% to 100%), whether the transaction involves a loan, and how many people originally owned the company. Most ESOP transactions move through four phases: pre-feasibility, feasibility, design, and the transaction itself.

Pre-feasibility: The first phase is to determine whether an ESOP is a potential fit for the goals of the current owner and the company. Some clear-cut situations, such as the size of the company, may make an ESOP impossible, so companies should review the ESOP threshold questions. If an ESOP meets that basic threshold, company leaders should explore whether an ESOP can meet their specific goals for the direction of the company. The ESOPs and Alternatives Matrix is designed to answer that question, and our online booklet Who Should Own Your Business After You? is a quick review to help leaders determine whether to move to the next stage.

Feasibility study: When company leaders determine that an ESOP has sufficient potential to invest in a feasibility study, they usually hire an outside advisor to help them examine the current and projected profitability of the business and perform a preliminary valuation. Feasibility studies may be simple, or they may include an analysis of several different exit strategies for the current owners to consider. In the simplest situations, with a small company, a minority transaction, an experienced insider, and a simple plan, the company may conduct the feasibility analysis itself.

Design: If all parties choose to continue after the feasibility study, then the next steps are to design the transaction and the plan, by

  • Analyzing the pros and cons of alternative ESOP transaction structures
  • Assessing the possible sources of financing for the transaction (if applicable)
  • Designing the benefit plan features of the ESOP, from participation requirements to vesting
  • Although it is not required at this stage, many of the most successful ESOP companies devote time during this phase to planning communication and education for the work force.

Transaction: To complete the transaction, the company establishes the ESOP trust and appoints the ESOP trustee. The trustee will hire an appraisal firm to perform a valuation of the stock the ESOP is acquiring and will ensure that all terms and conditions of the transaction are in the best interest of the future plan participants.