Selling to an Employee Stock Ownership Plan (ESOP) vs. Selling to a Third Party
Using an ESOP for business transition can be complicated, but selling to an outside buyer is often uncertain and even more complicated, with less flexibility and fewer tax benefits. This infographic compares these alternatives side-by-side. For example, a sale to a third party offers no special tax benefits, whereas a seller to a C corporation ESOP can indefinitely defer taxation, and ESOP-owned S corporations have no tax bills to fund. And outside buyers usually want to buy everything and all at once, whereas an ESOP can buy any amount and can buy gradually over time, allowing the owner(s) to gradually transition.
Sale to an ESOP vs. Sale to a Third Party
Using an ESOP for business transition can be complicated, but selling to an outside buyer is often more uncertain and complex, with less flexibility and fewer tax benefits.
- C corporation sellers can indefinitely defer capital gains taxes if the ESOP owns 30%+ of the company after the sale.
- ESOPs in S corporations, where taxation flows through to the shareholders, are exempt from income tax, so if the ESOP owns 100%, the company no longer has a tax bill to fund.
- Sales to third parties are generally taxable as capital gains; no deferral or exemption comparable to the ESOP ones is available.
- ESOPs can buy any percentage of stock from any number of sellers.
- Owners can sell gradually and ease out of the business on their own timeline.
- Third-party buyers almost invariably want to buy the entire company, all at once; gradual exits are rarely an option.
- Escrow is usually not required.
- ESOP deals provide flexibility in financing.
- Compliance with ERISA and Internal Revenue Code rules is required, but there is much flexibility in plan design.
- Escrow is held back from the seller.
- Financing may fail, derailing the deal.
- Earnouts are often required (typically 10%–20%).
- Buyers may want to buy assets, creating tax and liability issues for the seller.
- Buyers may require price adjustments if the company underperforms post-transaction.
- An outside appraisal is required (except for public company ESOPs); the valuation is based on fair market value.
- In smaller deals, an outside appraisal is not required but recommended; in larger deals, the price is usually set by a controlled auction.
- Costs are typically $150K–$400K for closely held companies (2%–4% of the transaction price).
- A simple, nonleveraged ESOP can cost under $100K.
- The company pays these costs.
- Legal, appraisal, and other costs vary, but generally total 4%–9% of the transaction price—much more than an ESOP.
- Business brokers charge sellers up to 12% of the deal.
- Buyers usually pay diligence, financing, and legal fees.
- Feasibility studies assess payroll and cash flow to determine how much stock can be purchased. They can be done internally or with expert advice.
- Forensic due diligence is rarely needed.
- Companies must prepare a detailed description of the firm and its finances, prospects, and risks.
- Buyers will want a forensic due diligence investigation; sellers should do the same to assess the financial soundness of the buyer and the terms of the offer.
- Once the seller decides on an ESOP and its basic structure, 4 to 6 months.
- The median formal offer-to-sale time is 10 months for companies in the small to mid-market range.