For business owners approaching a transition, deciding what comes next can be as important as everything it took to build the company in the first place.

An owner may want to create liquidity, while maintaining the culture and values that have shaped the business, and ensure the next generation of leadership has a thoughtful transition plan that supports both the people and the company.

Employee Stock Ownership Plans (ESOPs) can be one option for business succession planning, allowing owners to transition ownership, create liquidity and preserve company culture through employee ownership. For companies that established an ESOP years or decades ago, the planning considerations look somewhat different and equally important.

can be one option for business succession planning, allowing owners to transition ownership, create liquidity and preserve company culture through employee ownership. For companies that established an ESOP years or decades ago, the planning considerations look somewhat different and equally important. Chad Schaller, who brings nearly two decades of experience across leveraged finance, mergers and acquisitions and ownership succession.

"Many people view an ESOP primarily as a liquidity event for the seller," said Schaller. "We believe it's equally important to understand how the transaction will shape the financial future of the employees, management team and company that will operate within that structure for years to come."

Key Takeaways

• ESOPs can help business owners transition ownership as part of a broader business succession plan while creating continuity and preserving company culture.
• An ESOP may provide liquidity to owners while giving employees a meaningful ownership interest.
• ESOP financing and capital structuring require careful planning to support both the ownership transition and the company's long-term financial health.
•  For mature ESOPs, ongoing planning around repurchase obligations, leadership succession and capital structure is essential to sustaining long-term employee ownership.

Why More Business Owners Are Considering ESOPs for Succession Planning

Succession planning is becoming an increasingly important consideration as business owners across the country age.

According to Ownership Capital Lab, an estimated 3 million Baby Boomer-owned businesses face ownership transition, and 75% do not have a formal succession plan. An ESOP offers one approach, allowing a business owner to sell some or all of the company to an employee ownership plan without necessarily changing the company's leadership or direction.

Research from the National Center for Employee Ownership has found that employee owners at ESOP companies have higher wages and household net worth than comparable workers. Today, more than 6,600 ESOPs operate in the United States, representing more than 15 million participants and more than $2 trillion in assets.

Understanding How an ESOP Works

An Employee Stock Ownership Plan is a qualified retirement plan that holds shares of a company on behalf of its employees. Employees receive beneficial ownership through the ESOP trust as shares are allocated over time.

In a leveraged ESOP transaction, financing is used to fund the purchase of company shares, with debt generally repaid over time through the company's cash flow.

For the owner, an ESOP creates liquidity. For the business, it provides a path for ownership to transition while preserving leadership continuity and building employee wealth.

Is an ESOP Right for Every Business?

While an ESOP can be an effective strategy, it is not the right solution for every company. Family succession, management buyouts and sales to strategic buyers or private equity firms may also be appropriate depending on the owner's goals.

Evaluating an ESOP should be part of a broader succession planning process, not a standalone financing decision.

What Happens When an ESOP Matures?

As ESOP companies mature, planning priorities often shift from completing the original transaction to managing long-term financial, leadership and ownership considerations.

Many of the ESOPs operating today were established 10, 20 or even 30 years ago. As these plans mature, the financial and operational dynamics of employee ownership evolve, and so do the planning needs of the companies that sponsor them.

Repurchase Obligation Planning

As employee-owners retire or leave the company, the ESOP is generally required to repurchase their shares at fair market value. For mature ESOPs, this obligation can become a significant and growing financial commitment. Proactive repurchase obligation studies can help companies understand projected buyback needs and develop strategies to fund them sustainably.  Identifying and mitigating sudden impacts on cash flow are fundamental factors when advising CFOs and CEOs on how to appropriately forecast cash needs.

Leadership and Management Succession

Founders or long-tenured executives who were part of the original ESOP transaction may be approaching retirement. Identifying and developing the next generation of leadership is a critical priority, one that requires thoughtful planning to ensure management continuity supports both company performance and the long-term value of the employee ownership stake.

Capital Structure and Refinancing

As a mature ESOP company's financial profile evolves, so may its capital needs. Companies may seek to refinance existing debt, access growth capital or restructure their balance sheet to better support the repurchase obligation and other long-term commitments.

"A mature ESOP is a sign that employee ownership is working," said Schaller. "But sustaining that success over the long term requires the same kind of intentional planning that went into establishing the ESOP in the first place."

Looking Beyond the Transaction

A successful ownership transition doesn't end when the transaction closes. The company still needs to grow, invest and serve its customers. For mature ESOPs, the decisions made around repurchase obligations, capital structure and leadership development today will shape the health of the employee ownership plan for years to come.

"It's important to look at the entire picture," Schaller said. "The financing needs to work for the seller, but it also needs to support the employees, management team and company over the long term."

FNBO's ESOP lending practice brings together financing expertise and a long-term perspective to help business owners evaluate and execute employee ownership transitions and to help established ESOP companies sustain the structures they have built.

Helping employees understand the long-term value of ownership is also an important part of a successful ESOP strategy. Providing education, resources and access to experienced advisors can help employee-owners better understand the opportunities and responsibilities that come with ownership.

To learn more about FNBO's ESOP lending practice, contact Chad Schaller. 

About the Author

John Grose leads FNBO's operations in the Omaha, Lincoln, Beatrice and Fremont markets. In addition to his regional leadership role, John serves on the Business Segment leadership team with responsibilities for driving the strategic direction of the bank's digital experience and contributing to ongoing enterprise strategic initiatives focused on process transformation.