Why Consider an ESOP?

In most cases, ESOPs are formed by an owner who is looking to transition ownership of the business. Owners frequently find ESOPs attractive because they aren’t required to sell 100% of the business when forming an ESOP. In fact, a good percentage of ESOPs that are formed start with ownership of a minority interest in the company – somewhere between 30% and 49% is fairly common – so that the original owner(s) can retain a majority stake in the company. In a lot of those cases, the owner will ultimately sell the rest of the company to the ESOP in later stage transactions so that the ESOP eventually owns 100% of the company.

Business owners find ESOPs attractive (compared to other exit strategies) for several reasons:

1. It allows them to transition the business in stages, rather than having to do it all at once. They may (and frequently do) first only sell a minority stake in the business at first, allowing them to maintain full control over the business. If employee ownership is working well, the owner can later do a "second stage" transaction in which more of the stock is sold to the ESOP.

2. Operational control of the company largely remains the same after the transaction. The roles of the leadership and management team doesn’t need to change, and frequently doesn’t. It is much less disruptive to the business than a sale to private equity or a strategic buyer, which typically brings in “its” people. Even where the ESOP owns a majority of the business, the legal owner, who is the ESOP trustee, is not engaged in day-to-day business operations.

3. The legacy and the culture of the business can be preserved through an ESOP. One significant fear that we hear from business owners is that an outside buyer will come in and uproot much of what made the business great, including its people and its culture, in pursuit of a subsequent sale of the business. That's not the case with an ESOP because the systems and people who put the business's culture in place will stay.

4. The ESOP allows business owners to reward the people who helped them build the business into what it is when they decide to transition out.

Occasionally, companies will form “non-leveraged” ESOPs where, instead of having the ESOP borrow money to fund the purchase of a large block of shares, the company will simply make a contribution of shares to the ESOP, which are immediately allocated to the accounts of eligible employees. With this method, it will take some time for the ESOP to own a significant stake in the company.