5 Factors to Consider Before ESOP Implementation

Implementing an Employee Stock Ownership Plan (ESOP) is not a quick or easy decision. It requires forethought and planning. ESOP formation forces a company to think about not only the practicalities and financials of ESOP implementation, but also the impact on the company’s culture and the business owner’s legacy vision.

What is an ESOP and How Can You Implement it For Your Business?

ESOPs serve two different purposes. In the first instance, they are a way to sell your business to your own employees. In the second instance, they are qualified retirement plans that are offered as an employee benefit.

When an ESOP is formed, the controlling business owner sells his or her ownership in the company via company shares to an ESOP trust. The trust purchases these shares and deposits them into employee participants’ ESOP retirement accounts according to a set formula and schedule. Employees are able to apply for a distribution from their account upon retirement or leaving the company, as long as they have met the vesting requirements.

ESOPs have benefits for the sponsoring company, the business owner, and employees, but the ESOP implementation process is not something that can be undertaken on a whim. It requires a deep analysis of both the company’s financial position, the selling owner’s expectations for the sale and transition, and the reaction of employees.

Companies that are interested in forming an ESOP should seek outside counsel from an ESOP consultant to gauge if an ESOP makes sense for their business and is feasible. From there, ESOP implementation can begin.

5 Questions to Consider Before ESOP Implementation

We have compiled five questions to consider before heading down the path of ESOP implementation. Your answers these questions can help you determine if an ESOP makes sense for your business or not.

• What is ESOP implementation going to cost?

Forming an ESOP is expensive with costs starting well over $100,000. These formation costs cover the necessities of forming the ESOP trust, hiring valuation appraisers, and fees for various legal and professional services associated with formation. However, an ESOP will also have ongoing maintenance costs that should be factored into your analysis. An ESOP consultant will be able to help you estimate these ongoing costs in addition to the ESOP implementation costs.

• What is the size of your company?

Companies that form ESOPs must be profitable and have stable, preferably increasing, cash flow in order to afford the contributions and distribution payouts to employees. ESOPs are not a good choice for start-ups or very small businesses and, in fact, are only available to S-Corps and C-Corps. Most ESOPs are formed by companies that have at least 20 employees and annual revenues of several million dollars. Another thing to consider is your employee turnover rate. Companies with high turnover do not reap the benefits of an ESOP because there just isn’t enough longevity and continuity to support employee participation.

• What are your goals for the sale?

What are the owner’s expectations for selling the business? Is the goal to sell the business for the highest price possible? If so, an ESOP isn’t the best choice because sales are limited to fair market value (FMV). On the other hand, if the business owner is more interested in sharing the wealth and benefits of ownership with employees or ensuring the business continues to exist after their exit, then an ESOP makes sense.

• Are the management and leadership teams ready?

Having a strong succession plan in place is vital to the success of ESOP implementation. Not only does this set the tone for internal processes, roles, and continuity, lenders will want to see the succession plan before signing off on a loan. Since most ESOPs are leveraged, you need this lender buy-in to form the ESOP. Learn more about leveraged ESOPs and how they work here.

• How will ESOP implementation impact your company legacy?

One of the biggest drivers in ESOP formation is an owner’s desire to leave a legacy. These are the owners who genuinely care about their business and their employees. They don’t want to sell their business to a competitor or shut it down. They want it to remain open, continuing to contribute to the community and employ the people who made the business a success in the first place. An added benefit is that the retiring owner can choose when and how to exit the business. Many opt for a gradual transition that allows all parties to come to terms with the change while setting the business up for future success. If keeping your business open and operational even after you retire is one of your top goals, an ESOP may be the perfect solution.

Is Your Business Ready For the ESOP Implementation Process?

ESOPs are a valuable employee benefit and effective transition tool for retiring business owners, but they require careful planning, must meet strict compliance requirements, and are not suitable for every business. If your business is considering an ESOP, contact an ESOP consultant to conduct a feasibility study and get answers to your questions.

Reach Out to Aegis Trust Company for ESOP Implementation Advice

Find out if an ESOP is right for your business and get advice on the ESOP implementation process from the team at Aegis Trust Company. We are ESOP consultants, providing ESOP transaction and trustee services to companies throughout the United States.