What's an ESOP?

Employee Ownership: An M&A Alternative

America's closely-held businesses create prosperity and bolster communities. But even the most enduring companies eventually reach an M&A crossroads, often with a range of options. Third-party sales and private equity deals create liquidity, but these transactions can eliminate jobs, diminish legacies, and yield hefty tax burdens.

What if you could monetize your equity, and maintain a meaningful role with your company, while securing the future of your business and its employees? It's possible with an employee stock ownership plan. ESOPs enable privately-held companies to sell equity, at an independent valuation, to an employee trust.

These are not stock option plans. Instead, an ESOP is an ERISA-authorized retirement plan that invests directly in employer securities.

Who is the Buyer?

An employee stock ownership trust buys company stock. The purchase price is negotiated between the sponsor company and an institutional trustee, based on an independent valuation.

How is it Funded?

Plan sponsors borrow money on the trust's behalf, in the form of third-party financing and/or seller notes. All loans are repaid by the employee-owned company, using pre-tax cash flow.

How is Stock Earned?

Full-time eligible employees are allocated company shares, proportional to their annual compensation. A portion of all ESOP shares is allocated annually. Employees generally vest in three to six years.

How do Employees Cash Out?

Vested stock is sold back to the company, at a current valuation, when employees depart. Former plan participants can roll their proceeds into another qualified retirement plan.

TAX-ADVANTAGED LIQUIDITY

Shareholders can defer or eliminate capital gains taxes on their sale proceeds, while their companies gain meaningful tax deductions and can become income tax-free entities, in perpetuity.

FLEXIBILITY & DIVERSIFICATION

Partial ESOP sales are common, as are follow-up transactions. That allows shareholders to de-risk with potential upside and enables companies to engage in future ESOP or M&A transactions.

ENGAGED EMPLOYEE-OWNERS

Full-time staff earn stock over time, giving them skin in the game and stability. Research has shown that employee-owned companies outperform their non-ESOP peers.

Employee Ownership Benefits, Pros & Cons

Leveraged ESOP strategies carry notable advantages compared to private equity and third-party transactions. Transactions are customizable, industry agnostic, and can be utilized by partnerships, as well as C and S corporations.

But it's important to understand the full range of costs, benefits, corporate implications, common use cases.

If you own or advise a private company, and you're considering a transaction, it's also wise to compare employee stock ownership plans against other M&A options.

For a comprehensive overview, download our reference guide.