Could An ESOP Be Right For Your Business? Key Takeaways From GBQ's Webinar

How ESOPs work, which companies make strong candidates, and why a feasibility study should come first.

Every business owner eventually asks: What happens to the company when I step away? Selling to a competitor or private equity firm is the familiar answer, but it can bring new leadership, a new culture, and new priorities. An employee stock ownership plan (ESOP) offers another path. It can give an owner liquidity for their ownership at a fair price, while keeping the company independent and allowing it to capitalize on tremendous tax advantages.

In the first session of GBQ's fall ESOP webinar series, Joseph Borowski, CFA, managing director of Valuation & ESOP Advisory, and Drew Dixon, manager, walked through the fundamentals.

What Is An ESOP?

An ESOP is a qualified retirement plan similar to a 401(k), with one key difference. Instead of holding mutual funds, the plan invests mainly in the stock of the company where the employees work.

In an ESOP sale, Mr. Dixon explained the stock typically enters the plan through a negotiated transaction, where the buyer is already known (an ESOP trustee). This trustee represents the employees and cannot pay more than “fair market value” for the stock the ESOP purchases. After closing, the plan gradually allocates shares to employees, often over 15 or more years, so future hires benefit as well. The company or ESOP then buys back shares when employees leave or retire, with an independent valuation to help the trustee set the share price each year.

Why Owners Choose Employee Ownership

Mr. Borowski boiled the appeal of an ESOP down to four primary reasons:

• Preserving the company's legacy and independence.
• Tax advantages for the company and the selling sellers.
• Liquidity for the sellers without having to shop the business to outside buyers.
• Rewarding the employees who helped build the company, and helping the company attract new employees.

The 100% ESOP Sale

Most ESOP transactions involve the sale of 100% of the equity to the ESOP, said Mr. Borowski, with the company operating as an S corporation afterward. This enables one of the most critical tax benefits of an ESOP – the ability to eliminate federal income tax. This is possible because the tax liability is passed through to shareholders of an S corporation, and the ESOP is a tax-exempt entity. The tremendous tax savings help repay the debt from the transaction and fund future company growth.

Is Your Company A Good Fit?

ESOPs work across industries and company sizes, from 25-person service firms to manufacturers with 2,000 employees. Mr. Borowski said strong candidates tend to share these traits:

• A deep management team that doesn't depend on the owner.
• Steady cash flow and limited existing debt.
• A stable workforce and healthy culture.

Conversely, an ESOP may not be the best fit for:

• An owner who wants all cash at closing.
• An owner who needs an immediate exit.
• A fast-growing startup that needs outside capital.

Mr. Borowski also suggested that involved owners consider selling to an ESOP five to 10 years before retirement. That leaves time for a leadership transition.

What You'll Learn In The Full Webinar

If you are interested in learning more about this topic, the webinar is a great place to start. You'll learn:

• How an ESOP transaction works, from the initial planning stage to the eventual sale, and beyond.
• What tax advantages are available to sellers and ESOP-owned companies.
• Which characteristics signal a strong ESOP candidate and which raise red flags.
• What governance looks like after the sale, including the roles of the board and trustee.
• How the transaction process unfolds, who is on the advisory teams, and why a feasibility study comes first.

Start With A Feasibility Study

Mr. Dixon described the ESOP feasibility study as the important first step in the transaction. It is a cost-effective exercise to (a) determine whether an ESOP is the right fit and (b) design the optimal ESOP transaction, addressing key issues such as:

• What purchase price and proceeds the sellers could receive.
• The impact of the transaction on the company.
• The benefits to management and employees.

Skipping this step, Mr. Borowski said, can lead to surprises, drawn-out deals, and higher fees. The next session in the series will take a detailed look at what goes into a GBQ ESOP feasibility study and will take place on October 20. Click here to register.

Talk to GBQ's ESOP Advisory Team

Do you have questions about the webinar, or wonder whether employee ownership fits your plans? GBQ's ESOP Advisory team works with business owners nationwide on feasibility studies, transactions, and annual valuations. Contact us to start the conversation.

Frequently Asked Questions

What is an ESOP feasibility study?

An ESOP feasibility study is an analysis done before a transaction. It estimates the company's value, models financing, projects cash flow after the sale, and shows what sellers would receive and what employees would gain. It helps owners decide whether an ESOP meets their goals before they hire a full transaction team.

Do employees run the company after an ESOP transaction?

No. Management typically stays in place. A board of directors oversees leadership. A trustee acts for the employee participants and focuses on share value, voting, and plan compliance rather than daily operations.

Can an owner sell only part of a company to an ESOP?

Yes. A trustee can buy any ownership percentage, as long as the ESOP pays no more than fair market value. However, a small ownership sale may not be worth it for most companies (extra transaction fees and administrative burden, for comparatively small tax, company, and employee benefits). The biggest tax benefits come with a 100% sale.