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      Resource Center

      When to Choose an ESOP Succession Plan Over a Conventional Exit Strategy

      Employee stock ownership plans (ESOPs) offer a number of advantages to sellers, companies and employees. ESOPs are a flexible tool for corporate and shareholder succession and offer benefits no exit strategy can match. However, those unique advantages are only worthwhile for those who find the very nature of ESOPs worthwhile. On the other hand, pure exit strategies (such as strategic third-party or private equity transactions) have advantages that ESOPs can’t promise. But they also come with their own costs and complexities. Neither side is perfect for every situation and both need to be evaluated carefully.

      The tables below are intended to help with the evaluation process. The first looks at the high-level differences and the perceived advantages and disadvantages of both ESOP and non-ESOP transactions. The second table looks at both sides of the ESOP coin itself.

      ESOP Succession Planning Versus Conventional Exit Strategy

      ESOP Succession Planning

      Conventional Exit Strategy

      ESOPs can be buyers or investors in almost any kind of profitable, valuable company in any industry.

      Not all companies can find third-party buyers.

      Similar to a “financial buyer,” ESOPs pay the appraised fair market value for the shares, which must be determined by the ESOP trustee's appraiser. An ESOP can’t pay a "strategic premium" based price.

      Private equity investors or strategic buyers will base the purchase price on their value of the company, which may be more than the company would otherwise appraise for, depending on timing in the market, the nature of the business or the buyer itself.

      Offer price made by an ESOP is made after due diligence is conducted and typically close to the actual closing price.

      Expressions of interest and opening offers are typically subject to due diligence, negotiation and adjustment between offer and close.

      The price paid at closing may not be 100% cash and may include seller notes. Upside warrants may be available.

      The price paid at closing may not be 100% cash. It may include contingencies, holdbacks and earnouts or seller notes,  which make the pricing less competitive to that of an ESOP.

      ESOPs don’t bring equity capital to the transaction; the only financing is supported by the company.

      Buyers can bring equity and financing to increase the cash portion of the transaction price.

      The owner doesn’t have to sell the entire company at once.

      Almost all transactions are 100% sales. In some cases, a private equity group will buy part of the company with the goal of the sellers and the private equity group all selling at some point in the future (typically within three to five years).

      Different sellers of different ages can sell over time.

      All shareholders must typically sell at once.

      Transaction success is entirely dependent on the post-transaction reliability of the company's performance and cash flow.

      Transaction success is less affected by company cash flow unless seller holdbacks or financing are involved.

      The selling owner can stay involved until they want to step away and management can stay the same.

      Sellers are typically not involved after a short transition period.

      The entire purchase price is deductible (both  principal and interest).

      Tax deductions are irrelevant, unless the seller is holding a note (which may pose a higher risk to seller).

      The owner of a C corporation can defer tax on the sale of stock to an ESOP as long as the ESOP buys at least 30% of the company and the seller reinvests the proceeds in U.S. operating company stocks or bonds within 12 months of the sale.

      That tax deferral can be permanent if the seller still holds those replacement investments at death.

      The seller’s beneficiaries get a step up in the tax basis of the investment and will only pay tax on appreciation after date of death.

      The sale is taxed as capital gain and ordinary income when paid; some tax planning can mitigate tax, but not defer or eliminate it.

      No commissions are paid to brokers. Legal, valuation and advisory costs of transaction are comparatively lower.

      Overall costs of transaction are higher, taking into account multiple counsel, investment bankers or brokers and accountants.

      An ESOP provides a succession plan when other strategies might not be available, such as:

      • Seller can’t or won’t sell to a third-party.
      • Management can’t raise the cash the buyer needs.
      • No family member(s) are willing and able to take over the business.

      The uncertainties involved in conventional exit strategies can leave an owner with no  succession plan in place, putting the company and employees’ jobs in jeopardy.


      Promise and Price: the Two Sides of the ESOP Coin

      ESOPs can be a boon for companies and employees in many situations. But with the promise of tax benefits and corporate performance there are tradeoffs and costs. Here are the two sides of the ESOP coin in scenarios where ESOPs can have the most significant impact on companies, employees and management teams.



      Studies show ESOP companies are more productive, faster growing, more profitable, have lower turnover and are more recession-resistant. An ESOP can strengthen company culture by aligning employees’ interests with those of management and owners.

      Studies show improvements in performance where ownership is coupled with participatory management structures.  A successful ESOP culture requires ongoing education and a healthy management culture that gets regular maintenance.  

      ESOPs may compel a company to further develop its management systems to net the productivity benefits.  

      The enthusiasm for an ESOP can be dimmed by ESOP fiduciaries who face personal liability if they breach their duties. Quality preventative advice and education are required.

      In either a C corporation or S corporation, the sale to the ESOP can be financed with tax-deductible contributions from the company to the ESOP that the ESOP uses to make payments for the shares. No other buyout structure allows the use of pre-tax dollars. Additionally, actual taxes saved by an S corporation ESOP can pay for between 30% to 60% of the transaction price.

      In a leveraged ESOP transaction, the debt taken on by the ESOP to finance the purchase is added to the company’s balance sheet.  Existing lenders are very interested in lending to ESOPs, but they need to understand how a leveraged ESOP works.

      In an S corporation, the ESOP’s share of the company’s income is free from federal income tax. In a 100% ESOP-owned S corporation, none of the corporation’s income is subject to federal income tax.  Cash that would have been spent on taxes is freed up to invest in the business and to support the cost of the ESOP, which includes the payment of administration costs and expenses. A well-run S corporation ESOP should have all of its operational expenses covered by saved tax money.

      Administering an ESOP requires money for third-party administration, annual valuations of the company, legal advice and trustee fees (if the plan has an external trustee).

      In an S corporation, there are limits on how much of the company’s stock a single individual or group of related individual ESOP participants can own. A company with few employees can easily hit these limits.

      An ESOP provides retirement benefits to employees with no employee contributions. Company contributions to an ESOP are typically higher than company contributions to a 401(k) plan.

      The company will need to reserve cash for the eventual cost of repurchasing vested shares from ESOP participants when they terminate employment due to death, disability or retirement. While death and disability can’t be predicted, third-party administrators, outside consultants, software or a spreadsheet can help plan for the repurchase liability caused by retirements. For C corporations that don’t have the flow-through tax savings, this is more complex than for S corporations.

      ESOPs are a good recruitment and retention tool for employees. As a broad-based incentive, employee ownership will attract better employees.

      ESOPs can’t be used to provide targeted hiring incentives. Individual plans outside of the ESOP may also be necessary to attract key executive suite talent.  


      ESOPs can be a tremendous tool that delivers value to sellers, employees and companies. Working with an expert to make a well-informed decision about whether an ESOP is the right choice for your company is a good investment. To get the guidance you need, contact Employee Benefits Law Group.