ESOP Planning


If you have decided to explore the option of an Employee Stock Ownership Plan (ESOP), there are a few steps you need to take to implement the plan. Prior to commencing with the actual planning process it is important to determine whether an ESOP is a viable option. 

ESOPs bring benefits to both business owners and employees. While there are clear financial advantages, there are also strategic and emotional benefits to these trusts.

Employees discuss ESOP planning.

Here are some of the benefits you can expect:

  1. Tax advantages for both parties: ESOP contributions are tax-deductible for C-Corporations and tax-exempt for S-Corporations. Contributions also grow tax-free for employees until distribution, potentially with deferred taxes if rolled over into an IRA.
  2. A properly planned exit strategy for business owners: An ESOP provides a guaranteed sale option for business owners to exit the company by selling to employees, allowing for a personalized transition plan.
  3. Retention strategy: ESOPs attract and retain employees as they provide a valuable tax-free retirement savings option and make employees feel valued as shareholders.
  4. Productivity: Employee-owners invested in the success of the company improve morale and performance, leading to increased teamwork and trust. In essence the employees have a vested interest in how well the company does, this does away completely with the idea that it is “just a job” or “just a salary”.
  5. Finance tool: ESOPs can borrow funds to obtain employer stock, which can be used to reinvest in the company, refinance debt, or acquire assets. ESOP contributions are tax-deductible, allowing companies to make payments using pre-tax dollars.

As most people are, you are now excited about the option of an ESOP for your business and we can’t blame you. 

Here is what you need to consider next:

  1. Interested parties: In order to implement an ESOP, it is important to first determine whether other company owners are all willing to sell. This step may seem obvious, but it’s essential to ensure that all parties involved are on board with the idea of an ESOP. The beauty of an ESOP is its flexibility when multiple shareholders are concerned.  For example, if one share holder wants to sell 100% of their shares and another shareholder only wants to sell 30% they can do that.  It is not a one size fits all transaction like other exit strategies.  
  1. Feasibility: An ESOP’s viability may be assessed by a feasibility study. This could be an in-depth analysis performed by an external consultant or a simple business plan performed in-house. The study must consider the company’s available cash flow, payroll for ESOP participants, and the repurchase obligation. Generally, the depth of the study would depend on the size of the company and separately to that is its perceived ability to repay the loan. 
  1. Valuation: A valuation of the company’s stock is an essential step in the ESOP implementation process. For public companies, this can be based on past price performance, as opposed to private companies, where it could be more speculative. In order to determine if the range of values produced is acceptable, a preliminary valuation may be performed first. The valuation will take into account factors such as cash flow, profits, market conditions, assets, comparable company values, goodwill, and overall economic factors. If the ESOP is purchasing less than 30% of the shares, the capital gains deferral is not an option for the selling shareholders.  

It is best practice to have a separate appraiser for the ESOP transaction and not the same appraiser who performed the preliminary valuation for the company or selling shareholders. The risk is just too high if you use the same appraiser that their objectivity could cloud the outcome which is not ideal. The ESOP trustee should select and hire the appraiser and scrutinize their work product and assumptions to ensure objectivity and independence. The company may pay the appraiser’s bills, but the appraiser’s client is the ESOP.

To summarize there are 3 steps involved in the process of planning for an ESOP:

  1. Information Gathering: The first step is to gather key information about the company and its financial and business objectives. This information is crucial to understand the feasibility of implementing an ESOP and how it would impact the company, owners, and employees.
  1. Effective Planning: If an ESOP is deemed the best strategy to achieve the company’s objectives, the next step is to plan effectively by determining the size, structure, financing terms, and other aspects of the plan. This analysis helps to ensure the feasibility of a successful transaction.
  1. ESOP Implementation: Once the appropriate structure has been determined, the implementation stage begins. This involves choosing advisors, negotiating terms and conditions, and documenting and implementing the ESOP in compliance with IRS/DOL regulations. ELG provides assistance throughout this process.

When deciding on the process of embarking on the ESOP route it is important to realize that this is not a journey you need to go on alone, we have the experience and expertise to guide you through every step of the process from discovery to implementation. 

As with any project the success thereof often lies not in the action but in the planning.

“Our goals can only be reached through a vehicle of a plan, in which we must fervently believe, and upon which we must vigorously act. There is no other route to success.” ― Pablo Picasso, painter