Is an ESOP the right exit strategy for your business?

David Nussbaum

For many privately held business owners, their company is not just an asset; it is a lifetime of hard work and the foundation of their personal wealth. As owners approach the end of their business life cycle, choosing the right exit strategy becomes a critical decision that can shape not only their financial future but also the legacy they leave behind.

While each situation is unique, most owners eventually consider three main exit paths: selling to a financial buyer (such as a private equity group), selling to a strategic buyer (often a competitor or someone within the industry), or selling to employees through an Employee Stock Ownership Plan (ESOP).

Each option offers distinct advantages and trade-offs. For example, financial and strategic buyers are frequently well-capitalized and can sometimes offer the highest sale price. However, there is more to the decision than headline price alone.

Understandably, the most common question we hear from business owners is, “How much can I sell my business for?” But this is quickly followed by, “How much do I actually keep after taxes?” And for some business owners, “What will happen to my employees, my company’s culture, my control of the company and its future direction, and my legacy if I sell?”

An ESOP allows a business owner to sell the company to its employees, creating a structure where employees become beneficial owners over time. While ESOP transactions often deliver a fair market price rather than the highest strategic premium, they can offer substantial tax benefits to the seller and to the company itself. In some cases, the after-tax proceeds from an ESOP sale can rival, or even exceed, those from a sale to an outside buyer.

For some business owners, the financial outcome is far and away their most important consideration. However, many business owners appreciate the value of other factors that they take into account. For example, an ESOP can help preserve the company’s culture and support the very employees who helped build the company. ESOPs can be a way to reward loyalty and hard work, protect jobs and keep the business rooted in supporting its local communities. For owners who care deeply about their legacy and how their company carries on in the future, these qualitative factors can be just as meaningful as the financial outcome.

For a business owner to confidently pursue an ESOP, several fundamental criteria should be considered, often involving the counsel of an experienced ESOP lender, such as Eastern Bank, and specialized advisors. Here are some factors to consider:

Business Size and Resources: While the ESOP model can be adapted, it typically works best for middle-market companies, generally those with annual revenue of at least $15 million. Additionally, administering an ESOP requires internal knowledge and capabilities and external expertise to help guide the process. The company should have finance and human resources employees who can manage the structure, track payments, understand the financial statement impact and effectively communicate the value of the benefit to employees.

Adequate and Sustainable Cash Flow: New ESOPs are typically financed through a combination of bank senior debt and a seller note. Regardless of the structure, the company must commit to repaying this debt, usually over a five-to-seven-year period. The business should generate consistent and predictable cash flow with stable operating margins in order to repay these obligations. The financial health and sustainability of the company are paramount, as employees’ future retirement wealth is directly tied to the company’s ability to service this debt.

Wealth Planning vs. Mission: The decision comes down to the owner’s personal goals. For mission-oriented business owners committed to rewarding loyal employees and ensuring the company sustains its business approach, the ESOP’s blend of financial opportunity and legacy preservation is unmatched. Maintaining operational control post-sale, often staying on the board — and in the same leadership role — for a transition period, provides an extra layer of consistency and reassurance for stakeholders.

The tax benefits of selling to an ESOP can be significant for both the selling owner and future company, with potential capital gains deferral and company tax deductions, but require careful planning. ESOPs often preserve jobs and values, though they demand financial stability and acceptance of fair market value.

Choosing how, and to whom, to sell a business is one of the most important decisions a business owner will ever make. For owners who want to balance financial goals with the desire to reward employees and preserve their company’s legacy, an ESOP can be an attractive option. However, ESOPs are not one-size-fits-all. They require solid cash flow, internal and external expertise and a willingness to accept fair market value.

Business owners considering their options should take the time to evaluate what matters most to them and their business.

David Nussbaum is a senior vice president, commercial team leader with Eastern Bank. The opinions expressed herein are those of the authors and do not necessarily reflect those of Eastern Bankshares, Inc., Eastern Bank, or any affiliated entities.