If you are considering stepping back or stepping away from your company, it can be difficult to choose the right path. Many business owners want to protect their legacy, reward employees, and create financial security for themselves and their families. That’s why more companies are turning to Employee Stock Ownership Plans (ESOPs) as a transition strategy that combines tax advantages with long-term stability. But when is the right time to sell to an ESOP? Below are some indicators your company may be ready.
Your company has stable earnings and healthy cash flow
A successful ESOP, especially a leveraged ESOP, depends on the company’s ability to generate consistent cash flow. Profits help fund the ESOP’s purchase of shares and support ongoing plan obligations.
You’re ready for succession or partial ownership transition
A sale to an ESOP is attractive when you want to:
- Gradually step back from day-to-day operations
- Take liquidity from the business without selling to a competitor
- Maintain control for a period of time
- Transition ownership in a flexible, staged process
- Reward those who helped or are helping to build the company
You want to protect your people and company culture
ESOPs are often chosen for cultural reasons. They allow owners to reward long-term employees, preserve identity, and maintain stability.
You have a strong leadership team in place
After the ESOP purchase, the company still relies on effective management. ESOPs work best when leadership is capable, experienced, and not driving the company forward.
Your company is a mix between being stable and growing
ESOPs thrive when companies show predictable performance, consistent customer demand, and/or a desire to grow.
You want a tax-friendly exit strategy
ESOPs offer powerful tax advantages, including:
- Tax-deductible ESOP contributions
- Section 1042 capital gain deferral (for C-corps) with S-corps being eligible in the near future
- Potential elimination of corporate income tax for 100% S-corp ESOPs
You’re comfortable selling at fair market value
ESOPs cannot pay strategic premiums. An independent valuation determines fair market value. Keep in mind that the tax advantages may outweigh selling the company at a premium.
Commitment to the ESOP
You understand the management of the ESOP:
- Repurchase Obligation
- Administrative and Compliance Costs
- Fiduciary Oversight Requirements
Is now the right time for an ESOP?
Businesses that are financially stable, culturally strong, and preparing for transition often find ESOPs to be a rewarding and tax-efficient exit strategy. If you’re considering selling to an ESOP and want to learn more, connect with Pat Sievert at psievert@myboyum.com to find out how Boyum Barenscheer can help.
About the Author
Pat Sievert, CPA and Partner at Boyum Barenscheer
Pat advises business owners on succession planning, ESOP structuring, and long-term financial strategy.