As a business owner contemplating the sale of your company to an employee stock ownership plan (ESOP), your first — and perhaps most important — step is finding the right partner. Knowing you’ve selected an ESOP advisory firm you can really trust empowers you to design a plan that meets your needs, strengthens the business, and delivers meaningful benefits to employee-owners.
While various advisors and attorneys may offer different recommendations based on their experiences and expertise, the reliability of an ESOP consultant’s guidance can also vary based on individual motivations — which may or may not be aligned with your best interests.
That’s why it’s imperative to critically evaluate not only the advice you receive, but also the source. An ESOP transaction is often a life-changing decision. You’ve invested a career, perhaps most of a lifetime, growing a healthy business. It’s certainly worth the investment of time to ensure your partners in the journey to employee ownership understand and support your goals.
Not Every Professional Advisor Understands ESOPs
One critical challenge in exploring the ESOP option is a widespread lack of knowledge among both business owners and advisors. Many accountants, lawyers, and financial consultants have little if any experience with ESOPs. This knowledge gap can impact the quality, depth, and breadth of advice they can offer. Advisors who lack a deep understanding of ESOP structures, regulatory requirements, and long-term sustainability issues may unintentionally steer you in the direction of what they’re most familiar with — which may not fully align with the best interests of your business or your employees.
There’s also a tendency for negative news to be more memorable than positive, and plenty of advisors can point to news stories of ESOP failures to support their own interests. This highlights the importance of advisor transparency in ensuring an ESOP is sustainable before moving forward. At ESOP Partners, our long-term experience providing third-party administrator services exclusively to ESOPs means our experts have seen it all and can help educate and guide you to make a confident decision.
Evaluating ESOP Advisors for Fit
The landscape of ESOP guidance is populated by various professionals, not all of whom share the same incentives, expertise, experience, or perspectives.
Most business owners are well aware of the conflicts that can arise among family members when subsequent generations take over a family-owned business, but they may not have the same awareness of potential biases and competing interests on the advisor side of the transaction.
Motivations that could cloud judgment or create undue pressures include financial stakes. The promise of winning a new customer could potentially incentivize some advisors or attorneys to steer a business owner toward an ESOP sale even if it’s not an optimal fit for the company. That could introduce the risk that advice might center more around the advisor’s own financial gain than the long-term outcomes for the business.
Roles and Responsibilities in an ESOP Transaction and Beyond
Legal counsel: Provides legal advice on the structure of the ESOP, drafts transaction documents, and ensures compliance with applicable laws and regulations.
ESOP Consultant: Assists in determining the financial feasibility of the ESOP and helps to structure the transaction in a way that meets the financial goals of the company and its owners.
Independent valuation expert: Conduct a thorough valuation of the company to determine the fair market value of the shares being sold to the ESOP; also acts as the trustee’s financial advisor.
ESOP Trustee: Serves as a fiduciary responsible for ensuring that the transaction is fair to the ESOP participants, acting in their best interests throughout the process, and acting as the buyer in the transaction.
Third-party administrator (TPA): Handles ongoing administration of the ESOP, including managing employee accounts, regulatory filings, and compliance with ESOP rules.
With experienced consultants and TPA services, ESOP Partners brings a unique breadth of expertise and perspective to bring clarity to our clients.
Misaligned Incentives Can Introduce Risks
An advisor with too vested an interest in the transaction itself might not fully explore whether an ESOP is the optimal solution for your business — or could gloss over important considerations around long-term plan sustainability.
For example, a plan’s transaction structure and design need to consider the financial burden on the company. If the transaction is overleveraged, the business could struggle to meet debt obligations and jeopardize its financial health. This scenario could arise in cases if an advisor doesn’t thoroughly evaluate the company’s cash flow, growth projections, debts, and growth potential.
Establishing an ESOP that’s fiscally sound and complies with regulatory requirements takes expertise and thoughtful guidance. An improperly designed and implemented plan can lead to financial risks, legal complications, and potential penalties. It could create an unwieldy added burden on administrators. Such a plan is unlikely to achieve its intended benefits for employees and the company.
Non-ESOP professionals who can’t compare apples to apples and focus on overall return rather than just transaction price may steer you away from an ESOP, even though it could be a great fit for your ownership transition and your long-term business goals.
Following the money trail can reveal misaligned incentives and shine a light on consultancies that might prioritize their own financial interests over delivering objective, client-focused advice.
On the other hand, a TPA dedicated solely to the ESOP industry has a vested interest in the long-term success of the ESOPs they manage. Unlike other advisors who might benefit from a quick transaction, TPAs are committed to ongoing ESOP administration and compliance, ensuring viability and success over the long haul. This long-term involvement aligns their incentives with your company’s and employees’ best interests to foster an ESOP that thrives well into the future.
Why an ESOP Isn’t the Solution for Every Business Owner
Several factors influence whether an ESOP is the best exit strategy for a business owner. First, company size and profitability are crucial considerations. For example, small businesses with inconsistent cash flow may struggle to realize the tax benefits that would fund an ESOP. Debt obligations are also an important factor — as they would be in any transfer of business ownership.
A company’s culture and employee engagement are also critical factors. ESOPs work best in environments where employees are motivated and invested in the company’s success. So, does a dip in employee satisfaction or an uptick in turnover rule out the ESOP option for your business?
In fact, an ESOP can be key to a long-term employee satisfaction and retention strategy. Becoming ESOP-owned can create fresh opportunities to address the issues proactively and holistically. An ESOP culture and communications expert can help you boost morale, reduce turnover, and foster a workplace culture that supports a successful and sustainable ESOP.
Red Flags to Watch for in Advisor Conversations
When discussing your ESOP decision with a prospective advisor, keep an eye out for:
- Downplaying or glossing over potential risks and challenges
- Pushing for rapid decision-making
- Lack of transparency about fee structures, compensation for services, or potential competing interests
- Limited experience or demonstrated success with ESOP implementations
Step-by-Step Guide to Vetting ESOP Advisors
To mitigate the risks of biased guidance, a thorough vetting process is helpful. Business owners who follow most, if not all, of these steps can choose with greater confidence:
- Attend industry conferences: Engage with ESOP professionals at industry gatherings. These events offer opportunities to network, ask questions, and gauge the expertise and integrity of potential advisors.
- Check references: Research backgrounds and understand an advisor’s track record with previous ESOP transactions to ensure they have a history of successful and ethical practices.
- Scrutinize potential conflicts of interest: Research advisors’ business practices to investigate whether financial incentives could influence their recommendations. A transparent advisor should openly discuss fee structures and how they align their interests with yours.
- Prioritize ESOP experience: Choose a consultancy with extensive ESOP experience. Seasoned professionals are more likely to provide comprehensive insights and help you navigate an ESOP’s complexities effectively.
- Evaluate their focus: Consider whether ESOPs are just a small part of the advisor's broader service offering or their primary focus. Advisors whose core business revolves around ESOPs are likely to have the depth of expertise, experience, and commitment to ESOPs to support your plan’s success.
- Verify fiduciary commitments: Review agreements with the advisor you choose to ensure fiduciary duties are upheld. Independent ESOP trustees and administrators are legally bound to prioritize the best interests of plan participants, adding a layer of assurance.
Partnering for Long-term ESOP Success
Selling your business to an ESOP is a significant decision with long-lasting implications. The value of objective, reliable guidance is hard to overemphasize. By carefully evaluating the motivations behind the advice, and by prioritizing independence and experience, you can navigate the process with greater confidence.
ESOP Partners has decades of experience guiding businesses through successful ESOP transactions — and our experts have worked closely with ESOP-owned businesses to correct plan design deficiencies and achieve compliance. Our comprehensive TPA services mean we experience all the ins and outs of administration and regulatory compliance — and we’ve seen and handled the challenges that can arise when biased or inexperienced advisors are involved.
Beyond the initial transaction, an ESOP can offer significant tax advantages, and employee ownership can support higher levels of engagement, productivity, and retention as employees stand to benefit directly from the company’s success with an added level of financial security in retirement. We’ve made it easy to start exploring whether employee ownership is right for you and your business. Take our self-serve quiz — just click below to get started.
