I sometimes sit down with owners who’ve already decided the private equity offer is the real number and an ESOP sale is a consolation prize. The purchase price on the private equity term sheet is often bigger, so the decision feels made before the conversation starts.
I understand the instinct. I also think it’s the wrong way to run an ESOP vs. private equity comparison.
My team and I take business owners through the process of selling their companies to their employees, from the first informational conversation to sitting beside them as their trusted sell-side advisor at closing. From that seat, we see a consistent pattern: the headline multiple isn’t the only important factor in determining what your company sale will net. Once you account for how the sale is taxed, what the deal terms end up paying out, and who runs the company the morning after the sale closes, an ESOP is frequently competitive with a private equity or strategic sale.
Sometimes it comes out ahead. Here is how I walk owners through the comparison.
Start With How the Sale Is Taxed, Not the Sale Price
When someone tells me they’ll net more from private equity, I don’t disagree that the number on the paper will be higher. A private equity firm or a strategic competitor will usually quote a bigger multiple than we see in the ESOP world. But peel the deal apart and look at the variables underneath it, and the glasses get less rosy.
Start with structure. Most private equity and strategic buyers want to purchase the assets of a company, not the stock. That’s good for the buyer, because the liabilities stay behind with the seller. It’s hard on the seller, because an asset sale is taxed at rates close to ordinary income. That’s not what they want to see happen to the value of a company they spent decades building.
Tax liabilities vary, but this is a range we see:
Sell in an asset sale, and you should expect to net somewhere between 55% and 65% of the purchase price after tax. Sell in a stock sale, taxed at long-term capital gains rates, and you generally net 75 to 85 percent. An ESOP is a stock sale. That means the ESOP starts at the higher floor, even before you account for other advantages.
My honest correction to “I’ll get more from private equity” is this: the purchase price will be higher. What lands in your account will not automatically follow.
A Second Bite of That Apple
The 75-to-85-percent floor is where an ESOP begins, not where it ends. There are several legitimate ways to add to a seller’s return above a normal stock sale:
- Tax strategies applied in the year of the sale, or the year before, that reduce what you owe
- Synthetic equity (such as stock warrants) that gives the seller a second stake in the company’s future value
- Earned ESOP shares if the seller stays on as an employee-owner, which, at one of the company’s higher salaries, adds up over time
Stack those together and, in the deals my team models, we often see a seller approach 90 percent to sometimes even more than 100 percent of the transaction price. Selling at fair market value, stack that against a synergistic offer from a private equity firm or a competitor, and the ESOP owner frequently nets ahead.
That doesn’t come without a trade, and we’re direct with owners about it: an ESOP takes time to pay out in full. Most deals include a seller-financing component. The delayed gratification is what you exchange for the stronger after-tax return, and for maintaining control of the company after the sale.
Earn-outs are worth naming here, because they cut the other way. Private equity and strategic offers commonly attach one. A twelve-times-EBITDA offer might carry three of those twelve in an earn-out tied to post-close performance. If performance doesn’t meet expectations, neither will the number. In an ESOP, the purchase price is the purchase price. One could write an earn-out into an ESOP deal, but there’s little reason to, so we rarely see it.
None of this makes private equity a bad option. It is the right answer for some owners. The fallacy I correct most often is simply the belief that you’ll end up with more in your pocket.
What Happens to Your Control
Money is only part of the comparison. The rest is what happens to your authority the day after you sign, and this is where the three paths diverge sharply.
An ESOP transaction separates the change in control from the financial transaction. Practically, that splits control into two kinds: day-to-day operations and strategic control.
Day-to-day operations don’t change. The same people run the company after the sale who ran it before, until the owner decides otherwise. I tell owners, you could sell to an ESOP today and walk into the office tomorrow, and nothing would be different until you change something.
Strategic control looks a little different, and there’s a reason for it. To justify paying full fair-market value, the ESOP trustee has to show a change in control, because a controlling interest is worth more per share than a minority one. To be clear, the trustee is not trying to run your business. They are buying the company’s future cash flows — and they want you and your people to keep running it.
The way they demonstrate oversight is by forming a governing board, commonly about 12 months after the transaction, with at least one independent member. In most cases the former owner stays on as chair of that board until they choose to step away, especially while the company still owes them money. Indirectly, the seller keeps a hand on the strategic direction. It just takes a new shape.
Compare that to the alternatives. A strategic buyer usually wants you to stay long enough to hand things off, then runs the company their way. Private equity may keep you on, sometimes with an equity piece, but make no mistake about who is in control. What they say goes, and you may find yourself sitting and watching what they choose to do with the company you built, and to the people who helped you build it. Your presence is subject to the company’s ongoing performance, which is to say it’s subject to them.
When owners who sold to private equity tell me their regrets, it comes down to two things: value and control. The return turned out not to be what they expected, and they came to work one day and realized they no longer got to make decisions for the people they cared about.
Who Shouldn’t Sell to an ESOP?
The answer here is clear, and it’s not about industry or deal size. The owner for whom an ESOP isn’t right for is the one who wants to wash their hands of everything and walk away tomorrow.
An ESOP trades speed for return. You will not collect all of your proceeds at closing. When a feasibility study ends without the owner moving forward, the reason is almost always the time it takes to get paid. If a fast, clean break matters more to you than net proceeds or the future of the business, a third-party sale may genuinely be the better call. That is a real trade-off, not a knock on ESOPs.
The risk inside an ESOP lives in the same place as the reward: repayment. You sold your whole company and you are financing part of that sale, which is exactly why you stick around to keep the direction positive. An ESOP failure would be because the company couldn’t pay the seller back. And that’s why the feasibility study matters. Done right on the front end, it proves the deal is workable before you commit. After that, it takes something pretty major to knock the plan off course, because the company no longer pays federal income tax and has real room to service the debt.
Why You Should Run a Comparison Years Before You Want to Sell
There is no age or number that closes the ESOP door. What really closes the door is attitude: once you’ve reached the point where you just want out, you’ve probably waited too long.
So my advice to any owner even thinking about a transition is to run a feasibility study early and often, even three or four years out.
It does more than tell you whether an ESOP fits. It helps you envision the optimal structure and timeline, gives you room to tax-plan ahead of the sale, and buys you time to build the next generation of leadership so someone is ready to take the baton. When you become the bank, setting your successors up to succeed is setting yourself up to get paid. Their success becomes yours.
Not every business should become an ESOP. But very few owners run the real comparison before assuming a private equity firm or a strategic buyer wins on price alone. The multiple is where the conversation starts. But don’t stop there.
If you’re weighing an exit and want to see the three offers side by side on the numbers that actually reach your account, that is run a feasibility study early and often before you sit down with an investment banker.
*This article is general information, not legal, tax, or financial advice. For decisions about your specific plan, consult a qualified ESOP attorney, CPA, or advisor.
