Start Here: Using an ESOP to Buy Out Owners
Business owners looking to find ways to sell their ownership interests can consider selling to other buyers, liquidating in place, or selling to managers. None of these solutions provide what ESOPs do: the most tax-favored way to transfer ownership to the people who helped build the company, all while getting a fair price and providing a flexible role for the sellers in the future company.
ESOPs are a kind of retirement plan. A sale to an ESOP can be all at once or gradual, for as little or as much of the stock as desired. For the employees, no contributions are required to purchase the owner's shares. Instead, the company uses future, pretax profits to fund the plan’s purchase of shares. The purchase can be gradual, funded by annual contributions to buy shares, or the trust can borrow money to buy a large block or all the shares at once, If financed, the loan can come from a bank, a seller note, or (often) both, The owner can stay with the business in whatever capacity is desired. The plan is governed by a trustee who votes the shares, but the board appoints the trustee, so changes in corporate control are usually nominal unless the plan is set up by the company to give employees more input at this level.
ESOPs are not right for everyone, Companies need to have enough profit to buy the shares and continue to operate successfully. Initial costs, while lower that typical M&A fees, are significant. ESOPs work best in companies that have or create high-involvement cultures.
To get started thinking about an ESOP:
- Attend one of our in-person meetings.
- We have live and prerecorded introductory webinars as well.
- Our booklet Who Should Own Your Business After You? is a quick review to help leaders determine whether to move to the next stage.
- Our book Selling Your Business to an ESOP provides a more detailed look.
It can help to talk to other ESOP companies first. We can refer NCEO members to other members. Joining the NCEO has many other benefits as well, including free access to our webinars, our ESOP Q&A with 700-plus questions and answers, a highly informative newsletter, research reports and more, the right to call us any time with questions, discounts on events and publications, and an extensive document library.
If you decide an ESOP can work for you, the next steps are:
- 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 workforce.
Transaction: To complete the transaction, the company hires a law firm to draft the ESOP and transaction documents after consultation with the company regarding various options. 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.
Read our guide to choosing an ESOP consultant and then find yours in our Service Provider Directory.