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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What makes an ESOP not feasible?

Several factors need to be considered:

Are you financially strong enough? ESOPs are funded by contributions from the company. That means you must have the profits or cash reserves so that you can take on this expense and still run your business successfully. If you are unable to do a substantial leveraged purchase at this time, you may want to make annual discretionary cash contributions to the plan to buy stock more gradually as your profits allow.

Is management comfortable making employees owners? If management is not willing to treat people more like owners, an ESOP is rarely a good idea.

Will cyclicality issues make it difficult for the company to handle debt payments? A company may be in good shape financially, but be in a cyclical business, making it difficult to take on much debt. A leveraged ESOP may not make much sense in these cases.

Is there adequate collateral? A company may have adequate cash flow to service debt, but insufficient collateral for a bank loan. In this case, if there is a seller to the ESOP, the seller may be asked to pledge securities purchased with the profits from the sale to the ESOP as collateral. A common alternative here is for the seller to take a note with an interest rate a reasonable premium above senior debt.

Are the costs of setting up a plan too high? An ESOP generally will cost $150,000 to $500,000 although some larger and more complex deals can be more. For some smaller companies, these costs may be too much to bear. A cheaper alternative is an Employee Ownership Trust, which has few rules and no tax benefits, but costs between about $50,000 and $100,000 to set up.

Is price the primary driver of the sale? In some cases, sellers may be able to get a price from a third-party sale that, even after the tax benefits on selling to an ESOP are considered, is so much higher than what an ESOP can pay that the seller will decide not to do an ESOP. An ESOP can only pay what a financial buyer would pay, not what a synergistic buyer would pay. See our article Selling to an ESOP versus a Conventional Sale for more details.

Are the rules acceptable? Some sellers do not want to be constrained by the eligibility, allocation, and vesting rules of an ESOP. An Employee Ownership Trust is a good alternative, albeit one without any of the tax benefits of an ESOP.

Link to this FAQ Topic: ESOP Basics & Feasibility