Are ESOPs Good For a Small Business?

If you are a small business owner who is exploring exit strategies and/or employee benefit offerings, you have likely come across Employee Stock Ownership Plans (ESOPs). ESOPs are an option for small business owners who want to transition out of the business over time and/or who want to share the business’ success with their employees by making them part-owners in the company.

There are other reasons why a business owner may choose to create an ESOP, which we cover in our post, “Top 5 Benefits of an ESOP”. In this post, we want to address if ESOPs are a good choice for small businesses.

How Big Does A Company Need To Be For An ESOP?

Many business owners wonder if their company is big enough to be an ESOP. While there are no clear-cut numbers or size thresholds at which a company can become an ESOP, most ESOPs have at least 15 employees at the time of their formation. An ESOP is considered small if it has less than 100 participants. In 2019 (most recent data available), there were 6,482 ESOPs in the United States. More than half of those had fewer than 100 participants. These numbers show that a company does not have to be very big to make an ESOP worthwhile.

Perhaps more telling than size are the practical considerations to forming an ESOP, which we cover below.

Costs To Consider As A Small Business ESOP

ESOPs are complicated and costly to administer, which is one reason why we don’t see very many of them with fewer than 15 employees. Business owners need to weigh the costs of the plan in relation to the benefits and their ultimate goal(s) in forming an ESOP to determine feasibility.

Cost estimates are highly subjective, varying from one company to the next. Typical costs to forming an ESOP include:

• Plan design and documentation
• Government regulatory filings
• Annual independent business valuations
• Administrative costs to manage the qualified benefit plan
• Legal fees
• Financing costs if the ESOP is leveraged
• ESOP trustee services
• Future repurchase obligation studies

The National Center for Employee Ownership estimates the cost of an uncomplicated ESOP transaction to be between $100,000 and $150,000. This does not include the annual costs of maintaining and managing the ESOP or repaying any loans, if leveraged.

Costs Vs. Benefits Of An ESOP

Is the price of forming and maintaining an ESOP worth it? That is the key question – and it is not solely a financial question. During your cost-benefit analysis you will want to consider:

Costs:

• The cost of forming an ESOP.
• The annual cost of administering the ESOP.
• The administrative burden of managing the ESOP.
• Increased regulatory requirements and the accompanying scrutiny.
• Actual contributions to the ESOP from the company/owner.
• Dividends paid each year, if any.
• Purchasing of shares from participants seeking a distribution.
• Repayment of the loan, if a leveraged ESOP.

Benefits:

• Tax benefits to the selling owner, the business, and the employee-participants.
• An additional employee benefit that can attract and retain quality workers.
• The cultural and productivity benefits that being an employee-owner creates in the staff.
• Peace of mind in knowing that the business will be in good hands once ownership has transitioned.
• ESOPs can be used to raise capital and create liquidity for the company.

Other Considerations For Small Businesses Considering An ESOP

Even if an ESOP looks good on paper, there is more to it than that.

Successful ESOPs have investment and buy-in at all levels of the organization. Management needs to be on board, employees need to understand the benefits of participating, and the selling owner needs to be willing to relinquish control.

The business needs to be successful and profitable with minimal debt. It should be structured as a C-Corp or S-Corp and have a strong growth outlook and regular cash flow.

If the company is family-owned, be sure to have an open and honest discussion about ESOP formation and the roles and responsibilities of the family members going forward. A clear succession plan will help ensure a smooth transition for family members and employees.

Bottom Line: Can A Small Business Be An ESOP?

Can a small business be an ESOP? The short answer is Yes. In fact, many highly successful ESOPs are small businesses. Does that mean an ESOP is right for every small business? No.

As with every business decision, it all depends. It depends on your goals. It depends on cash flow. It depends on your current debt load. It depends on your growth outlook and plans for the future.

Aegis Can Help Determine If Your Small Business Is A Good Fit For An ESOP

If you are wondering if an ESOP makes sense for you, an ESOP feasibility study is a good place to start. These studies examine and analyze business metrics against your goals to determine if an ESOP makes sense before you invest too much in the process.

Contact Aegis Trust Company to schedule a consultation and learn more about ESOP formation. We have completed over 400 ESOP transactions and can help you understand how an ESOP could benefit your business and support your future.

Contact us to start your ESOP research today.