Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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Can a seller finance an ESOP loan?

Sellers can finance ESOP loans, provided the transaction is at a rate and on terms no less favorable to the ESOP than an arm's-length equivalent transaction. That does not mean the seller will be getting the same rate as a bank would for senior debt. In a typical transaction, the seller would take a note for part of the cost and be secondary to the bank, meaning the seller can justify a higher interest rate. If the seller finances 100%, because the loan would not be fully collateralized, a higher rate would again be justified. A safe seller note differential is about 4% above senior debt, although many sellers decide to take a lower rate.

Warrants may also be used. Warrants give the seller the right to buy company shares at a determined price at sale (usually fair market value (FMV) as determined by the appraiser) for some number of years (typically 5-10). Typically, the seller will take a note for part of the transaction, but at a lower rate of interest than could be justified. The present value of the foregone interest is calculated and used to buy warrants with a similar FMV. The idea is to provide the seller with an equity upside. Warrants add to complexity and fiduciary oversight and should be done only with expert advice from independent trustees and expert advisors.

Seller notes can be made directly to the ESOP, but it is better for them to be structured so that the company ends up being the note holder and reloans the money to the ESOP. This will avoid potential complexities if the loan needs to be adjusted later on.

Note that if using a seller note, only the face value of the sale can be reinvested in qualifying replacement properties for tax deferral purposes. So even though the note is paid off over x years, each payment cannot be rolled over. Sellers can use other funds they have or can arrange for ESOP notes, a special kind of bond designed to make it possible to use seller notes for the full amount.

For more information about seller notes, see Selling to an ESOP and Financing the Deal and the ESOP Pre-Feasibility Toolkit.

Link to this FAQ Topic: Financing an ESOP