Employee Benefits Law Blog

The short answer is YES! Here’s the plain‑English, straightforward version of how an ESOP works as a succession strategy:

1. The company sets up an ESOP trust.

2. That trust then buys some or all the owner’s stock.

3. Employees earn shares over time as a retirement benefit.

4. The company keeps operating - same management, same board.

5. Finally, instead of having to sell the business to a competitor, or shutting the doors completely, the owner ultimately sells to the people who helped build the business.

Sounds great, so what’s the catch? There is fine print and I wouldn’t be doing my job if I didn’t mention it.

1. The ESOP must be set up correctly. There are technical requirements under ERISA and the Internal Revenue Code. Get them wrong, and the IRS or DOL will not be happy. Consult with your legal advisor, this is NOT a DIY project!
2. The owner doesn't get to name the price. An independent trustee represents employees and makes sure shares are purchased for fair market value, based on an independent valuation. No sweet deals, for anyone.
3. The deal still must be funded. The ESOP’s purchase can be funded with company cash, bank financing, seller notes, or a mix of all three. This is where experienced advisors, valuation firms, and legal counsel really matter.
4. Employees don’t “buy in.” No one writes a personal check or mortgages their house. Shares are allocated over time, just like other retirement benefits.
5. The owner is not handing over the keys overnight. Management still manages; the board still governs. Employees don’t set their own pay or hire/fire each other just because they’re employee owners.

If succession planning is on your radar, whether you’re an owner or an advisor, ESOPs are worth understanding first before you rule them out. I’m happy to talk through when they work (and when they don’t).