A new NCEO paper, Why Selling to an ESOP Costs Less than Selling to Another Buyer: Breaking Down the Cost Differences (PDF; also see the embedded version below) takes a detailed look at the various cost components of selling to an ESOP versus selling to another buyer. The paper was based on conversations with multiple people involved in ESOPs and in exit planning generally. The bottom line is that selling an ESOP usually costs between 2% and 4% of the transaction price, while selling to another buyer usually costs between 5% and 10%. Of course, these are general findings, and some deals cost less, while others cost more. The cost as a percentage of the transaction value is smaller in larger deals and in deals with less complex structures and financing.
A well-structured sale of a company to an ESOP can be a win for sellers, employees, and communities. Despite this, owners of companies considering an ESOP to buy all or part of their stock are often concerned, and sometimes deterred, by the costs and complexity of setting up a plan. The fees are tax-deductible, but that is still undeniably a lot of money. It is generally a great deal less, however, than the costs of a non-ESOP sale.
Despite this, many sellers balk at the costs of setting up an ESOP, even if they will ultimately pay more to sell to another buyer. There is an important psychological difference regarding costs that may help explain why there is greater concern about the cost of setting up an ESOP than about the cost of selling the business to another buyer. In an ESOP sale, the company pays some of the fees up front and the rest at close. While these fees are tax-deductible and thus have a significantly lower real cost, they still come up front. Most sales to other buyers are much less costly up front. Sellers to non-ESOP buyers (or the company the seller owns) need to pay for financial, legal, and accounting advice, and they often want a valuation to help them determine what to ask for. But the highest cost of selling a company to a non-ESOP buyer, the success fee paid to find another buyer, is taken out of the transaction costs. In some transactions, other up-front costs are paid out of the transaction as well.
The story is similar for complexity. ESOPs are qualified employee retirement plans and thus subject to various rules to qualify for tax benefits. Most of these rules are the same as for other plans, such as 401(k) plans, but there are additional requirements for how stock is valued and how a transaction’s fairness is evaluated that require time and expert advice. There are also many alternative ways to structure deals, which is where much of the complexity comes from. But selling a business to any other buyer is complex as well, often involving contingencies that are not found in ESOPs, as well as teams of advisors on both sides.
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For an in-depth guide to ESOP transactions, see our book Selling to an ESOP and Financing the Deal.