Transitioning Through an ESOP

ESOP Incentives

Selling all or part of a business to an Employee Stock Ownership Plan (“ESOP”) is a very viable method of ownership transition. There are potentially a number of excellent incentives to a business owner for selling to an ESOP. 

First, the business owner can plan their retirement by periodically selling ownership interests to the ESOP, while still maintaining control of the business, to gain liquidity and diversify their retirement investments so that all of their money is not tied up in their business.

Second, while the owner will not maximize their sale proceeds by selling to an ESOP, a sale to an ESOP will ensure that the owner is realizing fair market value for their ownership interest. This fair market value will be established by an independent business valuation professional.

Finally, selling to an ESOP provides tax benefits, specifically for C Corporation owners, as capital gains on the sale can be deferred if the proceeds are reinvested as part of a Section 1042 rollover in a qualifying replacement property (QRP).

Drawbacks to Consider

Some consequences of selling to an ESOP are the cost to the subject business including the following:

The retention of an ESOP trustee;
A business valuation professional for an ESOP feasibility study and annual valuations of the company’s stock;
A financial advisor in addition to the legal expenses associated with establishing an ESOP.

Also, this option is not a potential match for all businesses. For instance, a good ESOP candidate should have at least 20 employees, and revenues of at least $10 million to ensure the company can meet cash flow, retirement contribution and stock buy-back requirements. Further, the company should have a strong management team and a stable team of employees.