If you're looking to exit your business without selling it on the open market, an Employee Stock Ownership Plan (ESOP) allows you to retain some control. Learn more from the business planning advisors at EP Wealth.

Using Employee Stock Ownership Plans to Exit Your Business

If you're considering an exit strategy that doesn’t involve selling your business on the open market, an Employee Stock Ownership Plan (ESOP) can provide a structured transition while allowing you to retain some control. This approach offers financial benefits, tax advantages, and potentially a way to preserve your company’s legacy. Keep reading to explore some key factors and possible advantages of using an ESOP as part of your succession plan.

Primary Exit Methods

An ESOP is a retirement and ownership program that allows employees to acquire company shares, giving them a stake in the business and a vested interest in its success. It also provides business owners with a strategic exit plan for retirement or sale.

There are two primary ESOP exit methods:

Full Sale

With a full sale, a business owner sells 100% of their company shares to the ESOP while exiting the company completely and transferring full ownership to the employees. This option offers immediate liquidity and a rapid transition out of management.

The transaction can be financed through bank loans, seller notes, or company cash. The owners can defer capital gains taxes if they reinvest in qualified securities.

Gradual Sale

In a gradual sale, the business owner sells their company to the ESOP in stages over time, allowing for a smoother leadership transition. This exit plan offers more flexibility in timing and structuring the exit and allows the owner to maintain control throughout the change, which can take several months to years.

Financing Structure

Now, let’s look at how an exit with an ESOP is financed. The company may borrow money from a bank or other financial institution to fund the ESOP’s purchase. Company contributions are used to repay those loans over time, and these loan payments are tax-deductible for the business.

Business financial planning is essential to managing adequate cash flow to service the debt. A gradual sale may help the company reduce or avoid debt because it purchases shares in stages.

Potential Advantages

There are several potential advantages of using ESOPs as part of your business exit strategy:

Tax Benefits

An ESOP is tax-friendly in a few ways. Generally, there is no immediate tax when the employee leaves the company. They are only taxed when they receive the distributions. Also, upon selling, the employee pays taxes at the long-term capital gains tax rate, which may be lower than regular income taxes. If the ESOP holds 100% of the stock in an S corporation, it may potentially avoid all federal taxes.

Company Culture

In a founder-led or family business, shifting ownership to employees with an ESOP might help prevent the culture shift that can occur when an outside buyer takes over. This may allow the original vision and mission to continue after an owner exits the business.

Fair Market Value

Because ESOP financing terms can be more favorable for employee-owned models, outside buyers may find it challenging to arrange equally attractive terms. An ESOP sale allows owners to exit the business at fair market value (FMV) while preserving company ownership and culture, rather than selling to a competitor.

Employee Benefits

An ESOP gives employees stakes in the business they work hard to build, in the form of stock through direct contributions, company contributions, or a combination of the two. As the company becomes more successful, employees benefit directly if the values of their shares rise.

Confidentiality

ESOPs help safeguard a company’s sensitive financial data, including valuations, strategic plans, and ownership details. Through privacy laws, non-disclosure agreements (NDAs), and restricted access to information, ESOPs are designed to maintain confidentiality and protect the interests of both owners and employees.

What Could Determine ESOP Exit Success?

When employees become owners through an ESOP exit, success depends on several factors:

• Strong Financial Foundation – A stable cash flow is crucial for meeting financial obligations and supporting long-term business stability.
• Effective Management Succession – A well-structured leadership transition helps maintain morale, uphold company values, and prevent disruptions that could affect growth and performance.
• Positive Employee Engagement – Employees who feel valued and supported are more likely to take ownership seriously, strengthening the company’s future.
• Guidance from Experienced Professionals – ESOPs involve complex financial and legal considerations. Working with professionals who understand ESOP structures can help keep the process smooth and compliant.

Partnering with EP Wealth can help you prepare for an ESOP transition. Find a business planning advisor near you.

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