When contemplating the sale of your business, owners tend to grapple with the challenges of earning a fair market value and the ever-evolving ever complex tax strategies to help you do so.
Both of which make a huge difference in what your life will look like after being a business owner.
This is where an Employee Stock Ownership Plan (ESOP) comes into play. ESOPs are not just a financial arrangement; they are a powerful way to positively impact both business owners and the businesses themselves. In this article, we will explore the top two compelling reasons why ESOPs are great for business owners and additional factors that shape the sale of your business, so you can decide if exploring this strategic tool is right for your business goals.
#1 You Earn A Fair Market Value For Your Business
Selling your business by way of an ESOP is a way to get paid out at a fair market value for your business. Meaning, it’s a bona-fide exit strategy for the business owner.
The advantage of an ESOP is not only does the owner turn a non-liquid asset, the closely held business into cash, but if the business is a C-Corporation taxes on capital gains at 20% may be deferred and may never be paid back. This does not happen with a third-party sale or a traditional internal sale (sale to insiders).
And because succession planning is a critical aspect of long-term business sustainability, this strategy can be a means to plan for your exit, the way you envision it.
ESOPs provide an effective solution for business owners looking to transition out of their business while ensuring its continued success. By selling the business to your employees through an ESOP, you can secure a fair value for their shares and, at the same time, pass the torch to a dedicated and knowledgeable team.
Not to mention, ESOPs can also offer tax advantages during your succession process, making it a financially viable option. The transition to employee ownership can be a smoother and less disruptive process compared to other succession strategies. This is true for a few reasons:
- It creates a ready market for your shares
- Your buyer (ESOP) knows your business to a greater degree
- Your buyer (ESOP) is motivated to move forward with the sale
Now, earning a fair market value for your business takes in account two aspects:
The Bank Loan
In many cases the liquidity to purchase the stock will be funded with a third-party lending institution, generally the business’ banking relationship or another bank that is accustomed to such transactions.
The bank lends funds to the business and, in turn, the business pledges collateral for the loan. The business then lends the same amount to the ESOP, the ESOP issues a note and pledges the stock it purchases as security for the loan from the company.
Lastly, the ESOP uses the loan proceeds to purchase the stock from the seller (the owners).
The Owner’s Note
An additional aspect includes an owner’s note. The business may also act as the bank, lending excess cash to the ESOP in exchange for an ESOP note and pledge to the stock to be purchased by the said ESOP.
These methods are not exclusive. In many cases, a bank loan and an owner’s note are combined to provide an optimum strategy for the owner(s) based on their specific goals and objectives.
#2 You May Elect QRP As A Special Tax Designation
Typically, tax would be due on the sale of your business. However, for certain entities and meeting technical requirements, the tax may be deferred. The deferral of the capital gains is through the use of replacing the closely held stock with qualified replacement property (QRP). Generally, this is a portfolio of domestic equity shares in publicly traded companies.
The tax on this transaction is further deferred until the shares are later sold. There is also a strategy in purchasing and lending domestic bonds that may be more beneficial in which no taxes are paid.
This strategy may ultimately be tax-free, should any of the designated QRP assets be held in the other’s estate. By holding the QRP designated assets inside of the owner’s estate the capital gains which had been deferred since the sale is often eliminated. The tax basis of the QRP assets included in an owner’s estate at death is step is ‘stepped up’ to the market at the time of death.
This strategy is especially beneficial to the owner(s) of the business by deferring or possibly eliminating tax due on the sale. The compounded effect of this strategy greatly enhances the wealth of the owner(s) and their respective estates.
Other Reasons An ESOP Benefits Business Owners
Aside from working to earn a fair value for your biggest asset and tax savings, there are other factors that might make an ESOP right for your business.
#1 Employee Motivation and Engagement
Anything you can do to boost employee morale, productivity, and overall engagement, is an option worth considering. When your employees become shareholders in your business, it creates a stronger sense of ownership and commitment. As part-owners, there is a personal connection to your business’ success – they are not merely working for a paycheck; they are working towards the success of the business in which they have a stake in. Just watch and see the progress that can be made to your organization’s goals with this new found ownership mentality. One of the best ways to meet your business goals is by creating continuity within your business. Continuity means retaining your employees, especially those key employees who have a disproportionate impact on your business. An ESOP helps put focus on the long game for your employees. Hence, creating continuity. Employees with ownership stakes are more likely to take a long-term perspective on your business’ performance. This can be particularly valuable for businesses that prioritize sustainability and long-term growth, as employees become more invested in the overall success of the organization. This alignment of interests between employees and the company can create a positive feedback loop, leading to a more engaged and motivated workforce.
#2 Attracting And Retaining Top Talent
We’ve said it before and we’ll say it again, attracting and retaining key employees for your business is crucial for its success. Crucial. With so much competition to find this top talent, a well structured ESOP provides a unique and appealing benefit for employees, helping your business stand out from all the noise. This is especially true for those with a long-term career outlook – which is what you want anyways for business continuity. These key employees will likely be drawn to not only competitive salaries but opportunities for ownership and financial growth. Furthermore, ESOPs can be a powerful tool for retaining these key employees. The prospect of building wealth through ownership in the company is a strong incentive to keep your employees for as long as possible. The stability you create for your business is incredibly valuable to maintaining a cohesive and experienced team, leading to increased institutional knowledge, and more efficient operations, increasing your business value. That is the goal, isn’t it?
Is An Employee Stock Ownership Plan Right For Your Employees And Your Business?
An ESOP is designed to address long-term growth and continuity in your business. This plan can help transform the potential pain points you may be feeling into a catalyst for your ultimate succession. And a smooth one at that. ESOPs offer various benefits for the right business owner. But, how can you be sure an ESOP is right for your business? If your business goals include receiving a fair value for your largest asset and special tax considerations, amongst other aspects, considering an ESOP might be part of your path forward in your succession plan. Since implementing and managing an ESOP effectively requires careful planning, communication, and adherence to legal and regulatory requirements, talking with an experienced professional at Consolidated Planning to learn about your options.
2024-166953 Exp. 1/2026
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
