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What is an Esop

protect & reward

Together we can develop a plan that will not only keep your legacy intact but will protect and reward those that helped build your company.

what is
an ESOP ?

An Employee Stock Ownership Plan (ESOP) is a retirement benefit plan for employees, like a 401(k), but with some important differences.  As opposed to a 401k, an ESOP does not accumulate shares of other companies in plan participant accounts, but instead, it invests primarily in the stock of the employer company.  Also, instead of reducing their current salary to build their account value, employees don’t use any of their money to fund ESOP accounts. ESOP employee account value growth comes from the employer’s financial performance, which of course aligns the interests of employee and employer.  Finally, an ESOP can borrow money to buy the sponsoring company’s shares directly from selling shareholders or from the company.  This is how business owners can use the ESOP to create a liquidity event or an exit strategy.

ESOP Advantages

Customized
Transaction

Customization of many of the transaction terms to fit the situation. For example, each shareholder can sell any interest they wish to sell – from a minority interest up to 100%, i.e., some shareholders can exit and others can stay.

Fair Market
Value

Contrary to popular belief, for whatever shares are sold to the ESOP, the selling shareholders can receive fair market value for their shares.

Cash at
Closing

Selling shareholders can receive significant cash at closing (amount will be determined by ability of company to obtain financing).

Leveraged
ESOP

A leveraged ESOP (“LESOP”) is simply an ESOP that has obtained financing to purchase shares of the company from existing shareholder or from the company itself.

Capital Gains
Deferment

Selling shareholders can permanently defer capital gains taxes on the transaction  that would have to be paid in taxes in a normal third-party sale. 

Retain Company
Control

Regardless of the amount of interests sold by the selling shareholders they can retain control of the business post – closing, or vest control in a management team (which could even include next generation family members).

Tax Exempt
Entity

The post-closing ESOP company receives significant tax deductions enabling it to pay little or no corporate taxes and, potentially, to receive refunds of any taxes previously paid. If the ESOP owns 100% of the capital stock after close, the company becomes what is essentially a for-profit, tax exempt entity.

Second Bite
of the apple

“Second bite of the apple” for the shareholders or for others the shareholders care about, typically equaling 30-40% of the equity value of the business, consisting of the seller financing warrants and non-qualified management incentive plan.

Retirement Benefit
Windfall

Employees get a retirement benefit windfall (i.e., not using any of their own money to fund the plan) and they can defer taxes to later in life when their tax bracket will likely be lower.

Common esop misconceptions

Considering ESOPs have not been as popular as selling outright to a private equity group there are many assumptions and misconceptions regarding the process.

  • Selling shareholders will lose control to employees
  • Management or employees will have to fund the purchase
  • The company must be a particular entity type
  • ESOPs are expensive to administer post-closing
  • Employees will have access to sensitive company financial information
  • Sellers will not receive a fair purchase price
  • ESOP will prevent a subsequent sale of the company
  • You need a large payroll

OUR MISSION

Helping business owners prepare for retirement or exiting their business in a dignified way. In addition, protecting their legacy, business culture, and their trusted employees.

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ESOP Transaction or third-party sale?

There are numerous benefits of deciding to sell through an ESOP transaction versus a third-party or private equity deal.

  • Due diligence process is less disruptive to business
  • Transaction is typically handled much more quickly than sale to a third-party
  • Holdbacks, earn-outs and indemnification claims common in third-party sales are much less likely in ESOP transactions
  • Purchase price is stable throughout transaction (i.e., no “deal creep”)
  • Company culture unchanged in an ESOP transaction
  • ESOP transaction can be customized to meet the goals of the selling shareholders
  • Legacy goals of shareholders can be achieved in an ESOP transaction
  • Confidentiality of business operations and trade secrets can be maintained (i.e., no competitors looking at sensitive Company information)
History
ESOPs may be mysterious to some but they are not new.

While most people, even people who are otherwise finance and transaction sophisticated, don’t know much about ESOPs. Employee ownership has been around a long time.  An ESOP which is a tax-qualified employee benefit plan designed to invest primarily in employer stock, was written into the tax code in 1921, but the first time an ESOP was used as a tool for business succession was in 1956. The laws creating the tremendous opportunities ESOPs provide to business owners and employees were enacted in 1974 and have remained mostly unchanged since.

Despite existing in their current form since 1974, there is much mystery and many misconceptions surrounding ESOPs.  We think this is primarily caused by professionals advising on ESOP transactions without the requisite experience.  There are definitely right ways and wrong ways to structure ESOP transactions.  Having gone behind the work of other advisors many times, we are often shocked at the mistakes that are made and the opportunities missed.

3 steps to implement your esop

1. information gathering

Similar to preparing a plan for strategic growth, key information must be obtained for review and analysis when considering an employee stock ownership plan for your company. A preliminary review of this information can help you clarify your financial and other business objectives.

2. Effective planning

If an ESOP is ultimately the best strategic choice for you to accomplish your objectives, ELG will assist you in exploring the appropriate size, structure and financing terms, among other areas, of your ESOP plan, to ensure the feasibility of a successful transaction. This analysis will model how the ESOP will impact the company, the selling owners and the employees.

3. ESOP implementation

Once the company and its owners determine the appropriate structure, the ESOP implementation stage begins. ELG assists companies in choosing advisors, negotiating key terms and conditions, and documenting and implementing the ESOP transaction in compliance with IRS/DOL regulatory requirements.

Get in Touch!

Let’s discuss how an ESOP can work for you. 

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