ESOP (employee stock ownership plan)

An ESOP, short for employee stock ownership plan, is a way for employees to own part or all of the company they work for. According to the National Center for Employee Ownership, ESOPs are defined contribution retirement plans governed by US retirement plan law. The company sets up a trust that holds shares on the employees’ behalf, and employees do not buy the shares themselves. The NCEO also notes that ESOPs are most often created to buy shares from the existing owners of a closely held company.

For a founder without a family successor, or with children who prefer not to own the whole business, an ESOP is one of the options for selling while keeping the company independent and rewarding the people who helped build it. A family may sell all of its shares to an ESOP, or only part, keeping a stake and sometimes a role in leadership. Because the plan is a retirement plan, it involves a trust, a trustee with fiduciary duties to the participants, and a formal business valuation.

ESOP or management buyout?

Both move ownership inside the company. A management buyout puts the shares in the hands of a small group of senior managers. An ESOP spreads ownership across a broad group of employees through the plan’s trust. Both are forms of liquidity event for the family.

Why it matters for succession

An ESOP answers who owns the company. It does not answer who leads it. If a family member stays on as chief executive or on the board after an ESOP transaction, they still have to earn the authority to lead, now with employee owners in the audience. The article when your child does not want the family business covers how families reach this kind of decision.

This is a general description only. ESOPs carry specific legal, tax and regulatory requirements, and the family should involve its lawyer, accountant and financial advisor before considering one.