The 6 Steps of an ESOP Transaction

ESOP transactions are the foundation of any employee stock ownership plan (ESOP). Although the specifics of a transaction vary from company to company, the fundamental steps or processes of an ESOP transaction are consistent across industries regardless of the ESOP plan design or company size. There are 6 essential steps in an ESOP transaction, which we outline below.

What is an ESOP Transaction?

The majority of ESOP transactions are considered leveraged transactions. A leveraged ESOP transaction occurs when the ESOP must borrow money to buy shares of the sponsoring employer’s stock. This money must be borrowed from a bank or regulated financial institution and is secured by the assets of the sponsoring company. ESOPs are unique in that they are the only type of employee benefit plan where the credit of the company and its shareholders can be used to finance the purchase of company stock.

ESOP Transaction as a Succession Plan

ESOPs are often used as part of a business owner’s exit strategy or succession plan - and for good reason. Unlike a buyout, merger, or sale, an ESOP transaction essentially allows the owner to sell the business to its employees while remaining involved in the future direction of the business and reaping tax benefits all the while. This gradual transition allows the business owner to ease out of their role, mentor the people who will take over once the transition is complete, establish a legacy, and take care of their valued employees.Many business owners, particularly those who started the business themselves, feel a strong sense of duty to preserve what they have built and to care for the employees who made the business successful. By establishing an ESOP, these owners can preserve their employees’ job security once the owner exits while at the same time protecting the character and culture of the company and providing employees with ownership interest in the company.

The 6 Steps of an ESOP Transaction Process

1. Determine Whether Other Owners Are Amenable. The very first step in any ESOP transaction is to find out if the plan is a fit for the organization. Does it meet the business goals of the current owners and management? If there is more than one owner, everyone must be on board with the plan.
2. Conduct a Feasibility Study. Once interest has been established, it is time to conduct a feasibility study. The purpose of this study is to obtain hard numbers and data regarding the future profitability of the business which can then be shared with lenders in order to facilitate the ESOP transaction. Our post on ESOP Feasibility provides a closer look at some of the questions that should be asked during this step in the process.
3. Conduct a Valuation. A company valuation is needed to determine the fair market value of the company and the to-be-issued ESOP shares. An independent, qualified valuation advisor or ESOP trustee should be sought for this step to ensure impartiality, fairness, and legal compliance. Aegis’s fiduciary committee consists of experienced attorneys, a certified public accountant, and an accredited valuation advisor who perform due diligence and work closely with an independent financial advisor to make valuation decisions.
4. Hire an ESOP Attorney to Design the Plan. Given the strict legal requirements surrounding an ESOP, an ESOP attorney is essential to any transaction. ESOP attorneys help companies navigate the legal procedures and complexities of ESOP transactions and are instrumental to plan design. The attorney will conduct due diligence, present options for ESOP transaction structures, design the benefit features of the plan, and prepare the financial and legal documents establishing the ESOP to minimize risk exposure and maximize business objectives.
5. Obtain Funding. Once the ESOP design and structure have been approved, it is time to secure funding for the transaction. There are no legal or regulatory requirements that dictate the type of bank from which money can be borrowed. Some businesses have strong relationships with commercial lenders and start there. Others prefer to work with lenders who have prior experience with ESOPs due to the complexities of the transactions.
6. Establish a Process to Operate the Plan. The final step is to create the ESOP trust and designate an independent ESOP trustee to administer the plan. The trustee will perform an annual valuation of the stock, ensure that the terms and conditions of the transaction are being met, and will routinely review company performance and financials. This is also the time to begin communicating the changes to educate employees about the plan.

How can Aegis help with your ESOP Transaction?

While the 6 steps listed above are a generic process that all trustees need to follow, Aegis has its own in-depth proprietary process for ESOP transactions. Our Founder and CEO, Robert Lesser, has over 35 years of experience as an ESOP attorney. He played a key role in developing the Department of Labor (DOL) guidelines that govern ESOPs giving Aegis additional insight and experience into the fiduciary responsibilities of ESOP trustees. Our team also includes valuation specialists and ESOP attorneys on staff, all of whom follow a proven, rigorous internal process that surpasses DOL standards. Use our contact form to learn more about our ESOP transaction services or to see how we can work with you.