The One-Stop ESOP Blog

In terms of exit strategies for business owners, the leveraged employee stock ownership plan (ESOP) transaction is popular for several reasons.

Many owners of small to midsize businesses have all or nearly all their wealth tied up in their company. As they near retirement and want to diversify their investments, or experience other reasons for needing liquidity, they may explore options for selling some or all of their ownership stake in the business.

You probably already know that ESOP stands for Employee Stock Ownership Plan. 

But what does ESOP mean? Well, an ESOP is a qualified retirement plan that offers distinctive cash and tax advantages to business owners and companies. ESOPs are designed to share those advantages with employees and the communities where they live and work, too. 

The many advantages of an ESOP require an in-depth understanding of, and scrupulous compliance with, regulatory requirements under both the Internal Revenue Service (IRS) and the Department of Labor (DoL).

That means, when you transition your company to an ESOP, you’ll need to commit to understanding many new terms, concepts, and requirements.

Just as a steady flow of cash is key to a healthy company, sometimes events in life demand access to liquidity. 

Small businesses make up 99.9% of U.S. businesses and employ 60.6 million people, according to the U.S. Small Business Administration. In 2018, over half of U.S. business owners were age 55 and over. As many baby boomers prepare to retire, questions surrounding selling a small business are more relevant than ever.

But retirement isn’t the only motivation a business owner may have when deciding on an exit strategy and succession plan. Whether you’re ready for your next opportunity, facing health challenges, or need liquid cash to meet other obligations, selling is often an unavoidable stage in the life cycle of a closely-held private business.

Most business leaders explore an Employee Stock Ownership Plan (ESOP) with an initial focus on a tax-efficient exit strategy and succession plan that also supports a healthy future for the business.

But employees are important company stakeholders, too, and an ESOP’s benefits to employees are substantial. 

How is an ESOP good for employees?

For business owners who are evaluating exit strategies, the first question is often, “How much money can I get when I sell my company?” After all, getting liquidity out of the business is often a primary reason for selling to an ESOP.

The answer to this question is not always as simple as a sale price. Selling to an ESOP can involve tax benefits and sale structure advantages that can net a seller more over the long term than even a strategic premium third party offer can deliver.

An essential step is establishing fair market value for the business, which in turn determines the ESOP company stock price. The company stock price is determined on an annual basis by an independent appraiser, as required under Internal Revenue Code Section 401(a)(28)(c).

A business owner exploring exit strategies or business sale opportunities wants to know what to expect to earn on the sale. That sale outcome is often expressed in terms of an EBITDA multiple as a calculation of the company’s enterprise value (EV). 

How does ESOP financing work?

Can I simply approach my business banker with an expectation they’ll finance an ESOP transaction?

Do I need to find a bank or lender that specializes in ESOP financing?

When evaluating exit strategies that involve the sale of a company, even experienced business owners may encounter situations that are entirely new to them. This can be the case during the process of deciding whether an ESOP is the best option for a controlled exit at retirement.

Employee stock ownership plans (ESOPs) and employee stock purchase plans (ESPPs) are both employee benefit plans that companies use to extend ownership benefits to employees. ESOPs and ESPPs both offer employers ways to help employees grow their retirement savings and build wealth.

In addition, both of these employee benefit plans can be powerful tools to promote employee engagement and a sense of shared culture and aligned values. Employees with an ownership stake in the business may be more attentive to the shared company vision and culture. That, in turn, can have positive effects on recruiting and retention, productivity, and long-term company success.

Despite their similar names, these two types of employee ownership benefits are quite different from one another. An ESOP is a qualified defined contribution retirement plan, so employees don’t purchase shares with their own money. An ESPP, on the other hand, is a plan that allows employees to use their own money to buy company shares at a discount.

When it comes to running a family owned business, succession planning is an often overlooked yet essential consideration. In fact, many family companies don’t last beyond a single generation. For those that do, succession planning is a must.

But the subject of ownership transition can be thorny in a family firm, and the issue can become even more complex when some children prefer to remain involved in the business while others pursue their own interests.