Who is a Good ESOP Candidate?

ESOPs can be a strong succession planning option for many closely held companies and business owners, but the strongest candidates share a few key traits, including:

• Consistent profitability and stable cash flow
• 25+ employees to support plan costs and deliver meaningful employee benefits
• Trusting environment
• Ownership culture of accountability and engagement across the organization
• Management team committed to long-term value creation

Ed Renenger, President and CEO of SES ESOP Strategies, tells us more about what successful ESOPs have in common.

The Ideal Private Company ESOP Candidate

Flexible plan design allows ESOPs to align with owner succession planning, management team goals and business operations of a private company. Employee stock ownership plans, however, also can be structured to operate successfully in a public company environment.

The ideal private company candidate will meet most of the following criteria:

Profitable 

Closely held companies with stable cash flow and reliable profitability are good candidates for an employee stock ownership plan as they can support a leveraged transaction, fund ongoing plan design and contribute to meaningful employee benefits.

From a financing standpoint, the long-term success of an ESOP depends on the company’s ability to generate earnings and manage cash flow to meet debt repayment and share repurchase obligations.

Consistent earnings also help to steadily grow company share value for employee owners, support the role of ESOP trustees and fund participants’ retirement plan benefits over time. As a general matter, companies with less than $1 million in adjusted pre-tax earnings (EBITDA) may not be a good fit given the administrative and fiduciary costs of establishing and maintaining the plan.

Minimum Number of 20 Employees

As a general guideline, companies with fewer than 20 employees may not be a strong fit for an ESOP due to compliance testing requirements that vary by transaction structure. However, this is not a bright-line threshold and should be evaluated on a case-by-case basis.

Trusting Environment

An ESOP is most effective when employees and management are aligned around the company’s long-term success and the teamwork needed to achieve it. A culture of accountability and engagement across the organization helps support productivity and growth of an ESOP over time. Strong alignment can also reduce turnover and encourage employees to investment in the company’s growth.