An Employee Stock Ownership Plan, or “ESOP,” is a qualified retirement plan, similar to a 401(k), which allows the employees of a company to become owners of the stock of their employer, while at the same time providing an attractive business succession plan for selling shareholders. There are over 6,000 ESOPs in the United States, and the number of participants in ESOPs has grown in recent years (source: National Center for Employee Ownership, “NCEO”). The NCEO’s most current data, coupled with the level of activity we are seeing in the market, confirms that ESOPs have become more popular than ever. Why are they so popular? Read on to find out.
ESOPs: The Big Picture…
Negotiated transaction leads to the sale of company stock (100% is most common) to employees via the ESOP
Sellers receive “fair market value” for the stock, and any proceeds not received at closing earn a fair interest rate
Operational control and management of the company does not need to change
Company legacy is preserved – employees and management are protected and jobs are retained
The ESOP ownership structure can create a 100% income tax-free entity
Studies show ESOP companies outperform other ownership models over time, through an improved ability to attract, reward, and retain employees
Not every company is well-suited for ESOP ownership. Companies with the following
characteristics typically make for the best ESOP candidates:
Enterprise Value of at least $1 million – There are transaction and ongoing administrative costs associated with ESOP ownership, and the smallest companies may not be able to afford them.
Profitable – Likewise, companies that are struggling to achieve profitability may not be able to afford the ESOP, and possibly as importantly, may not command a value that is attractive to selling shareholders.
Available borrowing capacity – Most company’s take on leverage to enable the ESOP to purchase the company’s shares from selling shareholders.
Strong leadership team – The ESOP ownership model is designed to last into perpetuity, so the business must have a succession plan in place as key managers retire.
Stable and motivated employee base – ESOPs work best when employees recognize they benefit financially through the success of the company, and remain employed long enough to accumulate shares.
Domestically-based employees – Foreign-domiciled employees may not be able to participate in the ESOP, although plans can be designed to give them comparable benefits.
If a company fits the criteria outlined above, and the shareholders are interested in transitioning ownership, an ESOP can be a true “triple-win” for the company, shareholders, and employees. ESOPs can be an attractive option for selling shareholders when they:
are ready to achieve liquidity for their ownership and diversify their wealth;
are capable of realizing certain tax benefits not available through a third-party sale;
wish to preserve the company’s legacy as an independent company;
wish to reward their employees who helped build the company; and/or
desire to sell the company in a manner that typically provides greater certainty of closure, with less time and cost.
Want to learn more?
You probably have more questions, and that is OK. We’ve answered many of the most common questions here. Feel free to check out our other educational materials below, or contact one of our ESOP experts for a chat.