In part 1 of our series on ESOPs (Employee Stock Ownership Plans), we discussed some of the basics of these plans, including some of the major benefits of this type of transaction for a business owner. 

According to the Financial Planning Association/CNBC Business Owner Succession Planning Survey released in 2015, employee stock ownership plans are an option preferred by 14% of business owners. Many owners look at an Employee Stock Ownership Plan (ESOP) as a viable ownership transition strategy that can help them achieve their retirement goals while also taking care of their loyal employees. However, they’re complex, heavily regulated and shouldn’t be attempted with proper due diligence and expert guidance.

ESOPs can work in almost all industries, including service, manufacturing, and professional firms, such as engineering and architectural firms. ESOPs are actually qualified retirement plans that fall under ERISA and they are regulated by the U.S. Department of Labor and the IRS. As a company-funded benefit, there are no employee contributions. Employers contribute company stock to each employee’s retirement account and the stock is repurchased by the company when the employees leave. ESOPs are the only type of qualified retirement plan that can borrow money, which is used to pay the owner for their shares.

For owners, it’s a tax-efficient and controlled means of selling stock. The ESOP trust acts as a shareholder, with certain rights under state law, but not involved in the day-to-day operations of a business. Employees are “beneficial” owners of the ESOP trust. For the business owner, the ESOP is a buyer of their stock. For employees, an ESOP is a company-funded retirement plan. And, for the company, it’s a corporate structure and finance technique.

Should You Choose an ESOP as your Ownership Transition Strategy?

With the proper planning, an ESOP can be an attractive business transition option for owners. It provides the current owners with the ability to retain control while providing ownership for the employees, liquidity to fund their retirement, and potential significant tax savings. However, developing an ESOP takes significant time, expertise, and money. And, while there are numerous advantages, ESOPs are not the right tool for every company owner. Additionally, as we mentioned, they are highly complex to set up and regulated heavily.

How to Determine if an ESOP is Right for Your Business

If you’re considering an ESOP as a business transition strategy, the first step you should take is to develop a Business Ownership Transition Plan (BOTP), which will help you to understand your goals, how much money you need from your transition, what your business is really worth and which transfer options, including the ESOP, you have available to you. In theory an ESOP might sound like an attractive option, but you want to be sure that it is best option for you and your business for the long term.

While ESOPs are used across numerous industries and types of companies, there are some characteristics that most of these businesses share:

  • Closely held private company
  • Minimum of 25 employees
  • Established track record of profitability and earnings growth
  • An owner who is interested in liquidity and a diversification of wealth
  • At least $3 million in enterprise value
  • An owner who is open to accepting a conservative value for their shares
  • A senior management team who supports the formation of an ESOP

Setting Up an ESOP: An Overview

ESOPs are highly regulated by government agencies and a lot of peoples’ interests are at stake, so you want to make sure that it is set up right from the beginning. You can pay a high price for doing it wrong.

If the ESOP continues to look like a good strategy once you have created your BOTP, it will be important to make sure that the costs of setting up the ESOP, which can be significant, do not outweigh the benefit. An ESOP Feasibility Analysis will provide you with the answer to this and many other questions you will have. If the Feasibility indicates that the business value is high enough for the owner and the cash flow is strong enough to support the plan, it’s time to assemble your team of ESOP advisors including: a company ESOP legal advisor, an ESOP trustee, an ESOP financial advisor, an ESOP legal advisor, and an ESOP plan administrator.

Next, you will need to secure financing from a third party or be willing to finance some or all of the transaction yourself. You’ll then work with your team to design the ESOP Plan and draft legal documents prior to closing. ESOPs require ongoing post-transaction administration, including: annual business appraisal, record-keeping and administration, repurchase obligations for employees, communications training and education, and legal compliance.

From the complexity of the plan setup to the significant impact on the company and its employees, an ESOP can’t be rushed. Each of the steps during the process requires a significant investment of time and resources for all involved. As with any Business Ownership Transition Strategy, you have to understand your situation and your goals, both financial and non-financial, before considering an ESOP. Once you decide to move forward, you want to make sure that you are working with advisors who have deep experience in ESOP creation and administration, valuation, and compliance to ensure success. If you’re still thinking an ESOP might be the right option for you, contact us to discuss your situation.  


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