Step-by-step guide to setting up an ESOP
By Todd Koch, CPA, MBT, CFP
October 26, 2022
There are many things to consider before you set up an ESOP. Here are seven steps to take to help you determine whether an ESOP is right for you.
Determine if the owners want to sell
It does not make sense to work on making an offer to buy a business unless there is a willing seller. It's not uncommon for business owners to talk about selling some or all of their company but it may not be what they really want to do.
Conduct a feasibility study
Whether you hire an outside consultant or prepare one internally, you want to assess whether there will be sufficient cash flow to follow through with an ESOP obligation. By evaluating thoughtful projections, you can evaluate whether there is sufficient cash flow to pay for the ESOP, whether there is sufficient payroll to allow for necessary ESOP contributions, and whether the company will be able to follow through on payments to participants as they retire.
Conduct a valuation
With private companies it is difficult to come to a specific value for a company. You may have an idea of what you believe the company is worth and you may have used this in your feasibility study; however, it would be wise to have a valuation completed. Preliminary valuations do not have to be as complete as a formal valuation, which will be part of the ESOP trustee’s process, but it is important to know whether your estimate of value is reasonable — both from the perspective of what the current owner would like to sell as well as the obligations to future ESOP owners.
Hire an ESOP attorney
If after the prior steps you are still on board with implementing an ESOP plan, you should engage an attorney. The attorney is a good resource, but you should now be informed enough to be able to describe to the attorney what you would like in your ESOP plan. Working together you should be able to design a plan that accomplishes your goals.
Hire a CPA that knows ESOPs
ESOP accounting is unique. You need to hire a CPA that understands how the accounting impacts company books, banking covenants, etc. Having an ESOP knowledgeable CPA on your team is very valuable and extremely important as you work through the process.
Obtain plan funding
Will the ESOP be funded by a bank, independent party financing or a seller note? Maybe employees may invest part of their retirement plan assets. The person providing the financing is important because there may be tax as well as design impacts that are important to evaluate when determining what is best for your plan.
Find a trustee
The plan should have a trustee to oversee the plan. The trustee can take directions from others or can be an independent trustee.
Hopefully this will help you along your ESOP journey. Good luck!
Todd Koch, CPA, MBT, CFP, is a partner at John A. Knutson & Co., PLLP
The Minnesota Center for Employee Ownership serves as a free unbiased source for education and resources around all forms of employee ownership. With 52,000 business owners over the age of 55 in Minnesota exiting their business in the next 3–5 years, there is a crisis looming. What will happen to their legacy, employees, community? Business owners will look to their advisers on how best to exit. Contact us for more information on how we can be a resource for you at www.mnceo.org or Sue Crockett, executive director at scrockett@mnceo.org.
