While setting up an ESOP can be expensive, it isn’t necessarily more expensive than a “traditional” sale of the business. Let’s take a closer look.
The first step in any ESOP transaction should be a feasibility study, which looks at things like financing options, the impact of additional debt on the company and its cash flow going forward, plan structuring alternatives, tax issues, and the impact of being either a C corporation or S corporation. This study typically costs from $10,000 to $20,000.
Assuming that the feasibility study produces good results, an independent trustee should be retained to represent the ESOP and its participants in the transaction. The trustee’s fee is typically in the $20,000 to $30,000 range. The trustee will also want to retain a valuation professional to determine the fair market value of the shares that will be purchased by the ESOP, along with a fairness opinion for the trustee stating that the overall transaction is fair to the ESOP and its participants. The cost of the valuation professional will be about $20,000 to $25,000. The trustee will also likely hire an attorney to review the stock purchase documentation, adding another $15,000 to $20,000.
The company will need an attorney to prepare any corporate documentation necessary for the company to adopt the ESOP, the ESOP transaction documentation, along with the ESOP plan and trust and participant communications. If bank financing will be obtained, the attorney will also need to review the loan documentation. The cost of a good ESOP attorney for all of this is usually about $40,000 to $50,000, although it may be less if bank financing isn’t used.
Bank fees to initiate the loan being made to the company will also need to be paid, and while those normally depend on the size of the loan, but something in the $25,000 range is fairly typical for most ESOP transactions. Fortunately, there is a good amount of competition among banks for ESOP loans, which can help reduce these fees. The fee for the bank’s attorney will normally be anywhere from $15,000 to $25,000.
Finally, a selling shareholder may want to hire a financial advisor to help assess investment options for their proceeds, especially if they are looking to defer capital gains taxes through Code Section 1042. Fees in the range of about 1% of invested assets are common.
Those costs can add up, but there is one major difference between an ESOP sale and an outside sale, which is that in an outside sale, the owner is usually hiring a business broker or investment banker to find a buyer and guide it through the transaction. Their fees, including “success fees” based on the final transaction price, can eat up a good portion of the proceeds – in many cases, at least 5%. So on a $10 million sale, the broker/investment banker gets $500,000 (or more), and the owner also still has to pay for many of the same costs that are required for an ESOP transaction, including attorneys, a valuation advisor, CPAs, and other advisors. So in the end, the sale to the ESOP may be less expensive than an outside sale, and it’s almost certainly going to be less complex because the trustee’s due diligence process will be much less adversarial than that of an outside buyer.