The ESOP Transaction Process: 6 Steps Business Owners Should Know

Every Employee Stock Ownership Plan (ESOP) begins with an ESOP transaction. Although specifics vary by company, the fundamental steps of an ESOP transaction are consistent across industries, regardless of plan design or company size.

Every ESOP transaction is unique, yet most will follow a similar process, from initial planning through establishing the ESOP trust. The six essential steps in an ESOP transaction are outlined below.

What Is an ESOP Transaction and How Does It Work?

An ESOP transaction is the process by which a company establishes an ESOP trust and sells company stock to that trust, on behalf of its employees. 

Most ESOP transactions are considered leveraged transactions. 

A leveraged ESOP transaction occurs when the ESOP trust must borrow money to purchase shares of the sponsoring employer's stock. This financing typically comes from a bank, a seller note from the selling shareholder, or a combination of both, and it is generally secured by the company's stock and assets.

ESOPs are unique in that they are the only type of employee benefit plan in which the company and its shareholders can use their credit to finance the purchase of company stock. In a typical transaction, the sponsoring company takes out the loan and then loans those funds to the ESOP trust. The trust then uses the funds to purchase shares from the company's shareholders. As the loan is repaid over time, shares are gradually allocated to employee accounts, giving the sponsoring company, its shareholders, and the ESOP trust distinct roles in completing the transaction.

The 6 Steps of the ESOP Transaction Process

Step 1: Determine Whether Other Owners Are Amenable 

The first step in any ESOP transaction is to determine whether the plan fits the organization. Does an ESOP meet the business goals of the current owners and management? If there is more than one owner, everyone involved must be on board before moving forward.

Step 2: Conduct a Feasibility Study 

Once you've established interest, the next step is to conduct an ESOP feasibility study. This study gathers concrete data and projections about the company's future profitability, which can then be shared with lenders to help facilitate the transaction. 

Step 3: Conduct a Valuation

A company valuation is needed to determine the fair market value of the company and the ESOP shares to be issued. Engage an independent, qualified valuation advisor to ensure impartiality, fairness, and legal compliance. At Aegis, our fiduciary committee consists of experienced advisors who perform due diligence and work closely with an independent financial advisor to make valuation decisions.

Step 4: Hire an ESOP Attorney to Design the Plan

Given the strict legal requirements the federal government has established for ESOPs, an ESOP attorney is essential to any transaction. ESOP attorneys help companies navigate the legal procedures and complexities involved and play an instrumental role in plan design. The attorney conducts due diligence, presents transaction structuring options, designs the plan's benefit features, and prepares the financial and legal documents needed to establish the ESOP. These activities help minimize risk exposure and maximize business objectives.

Step 5: Obtain Funding

Once the ESOP's design and structure have been approved, it's time to secure funding for the transaction. Financing often comes from a bank loan, a seller note from the selling shareholder, or a combination of both, and no legal or regulatory requirements dictate which bank can provide the funds. Some businesses rely on existing relationships with commercial lenders, while others prefer lenders with prior ESOP experience, given the complexity of these transactions.

Step 6: Establish a Process to Operate the Plan

The final step is to formalize the ESOP trust and designate an independent ESOP trustee to administer the plan going forward. The trustee oversees an annual stock valuation, ensures the transaction's terms and conditions continue to be met, and routinely reviews company performance and financials. This is also when companies should begin communicating the changes to employees, helping them understand how the plan works and what it means for them.

Why Business Owners Choose an ESOP for Succession Planning

ESOPs are often used as part of a business owner's exit strategy or succession plan. Unlike a buyout, merger, or sale to a third party, an ESOP transaction allows the owner to sell the business to its employees while remaining involved in its future direction and benefiting from meaningful tax advantages along the way. 

Taking a gradual transition also allows the business owner to ease out of their role, mentor the people who will take over once the transition is complete, establish a legacy, and take care of the employees who helped build the business. 

Many business owners, particularly those who started the company themselves, feel a strong sense of duty to preserve what they've built and to care for the people who made it successful. By establishing an ESOP, these owners support business continuity by keeping the company intact and operating as usual, all while preserving its character and culture. 

At the same time, employees gain a genuine ownership interest in the company they helped grow, creating an outcome that benefits the owner, the workforce, and the business itself.

How Aegis Trust Company Supports ESOP Transactions

While the six steps outlined above represent a generic process that all trustees must follow, Aegis Trust Company has developed its own in-depth, proprietary process for ESOP transactions, providing fiduciary oversight and guidance at every stage. 

Our Founder and CEO, Robert Lesser, has practiced law for over 40 years, with more than 30 years focused specifically on representing ESOP sponsors and institutional trustees. He also played a pivotal role in developing the industry's standard protocols with the U.S. Department of Labor (DOL), giving Aegis unique insight into the fiduciary responsibilities that come with serving as an ESOP trust company.

Our team includes valuation specialists and ESOP attorneys on staff who bring deep experience to every valuation, legal consideration, and due diligence requirement involved in an ESOP transaction. Once the ESOP trust is established, we can continue to serve in an ongoing trustee capacity. This means we monitor compliance, review company performance, and protect the interests of plan participants for the life of the plan.

As an experienced ESOP trust company, Aegis is committed to a rigorous internal process that surpasses DOL standards at every step. Reach out to learn more about our ESOP transaction services and to discuss how we can work with you.