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.

NCEO employee ownership FAQ hero (keyboard)

Can an earnout be included in a sale of an ESOP company?

It is possible to structure a transaction this way, but only with considerable caution. If the earnout is deemed an extension of credit by the plan, that could be a prohibited transaction.

One way around this would be to make the earnout payable at the exact moment at which it is earned. Another approach would be for the company first to buy out the ESOP and then sell, but that means the company must have the cash. 100% ESOPs almost by definition would not be able to do this.

There is no hard and fast rule on whether an earnout opportunity can be part of "adequate consideration" but the practical answer revolves around the likelihood of achieving the earnout and the degree to which there would not be "adequate consideration" if the earnout were not achieved.

In any event, there needs to be a fairness opinion as to the adequacy of the consideration the ESOP is receiving. Many advisors would say that this necessitates that the price be considered fair if the earnout is not achieved. That may make the sale less appealing to the buyer, of course.

If there is an earnout, it is treated much like an escrow and paid out as the earnout is achieved. It is unlikely that an earnout with a long term would meet fiduciary standards.

Link to this FAQ Topic: Distributions & Repurchase