ESOPs Explained: What They Are and How They Work

Miranda Kishel
7 days ago
2 min read

What Is an ESOP?

An ESOP (Employee Stock Ownership Plan) is a qualified retirement plan that gives employees ownership interest in the company. Instead of selling to an outside buyer, the business owner sells part or all of the company to a trust that holds shares on behalf of employees.

In plain terms:

An ESOP turns employees into beneficial owners—offering an exit path for the seller while rewarding and retaining staff.

It’s one of the few strategies that creates a win-win for both the owner and the workforce.

Why ESOPs Matter to Small Business Owners

For owners looking to exit gradually, retain company culture, and reward employees, ESOPs offer a flexible and tax-advantaged solution.

Here’s why they’re powerful:

Owners can sell all or part of the business.
Employees gain long-term wealth without buying in.
The company gets major tax breaks.
Continuity is preserved—no disruption from outside buyers.

According to the National Center for Employee Ownership (NCEO), there are over 6,500 ESOPs in the U.S., covering nearly 14 million employees—with growing interest among privately held businesses.

Common Examples or Use Cases

Retirement Exit: A 60-year-old owner sells 100% of the company to an ESOP, stays on for 2 more years as CEO, and transitions out slowly.
Partial Liquidity Event: The owner sells 30% to an ESOP and retains majority control while accessing cash and building a succession plan.
Employee Retention Strategy: A company facing high turnover creates an ESOP to retain top talent and align incentives.

ESOPs work especially well in industries with strong cash flow, stable leadership teams, and long-term growth potential—like engineering firms, construction, and manufacturing.

Related Terms and Misconceptions

ESOP vs. MBO (Management Buyout):
- An MBO involves a few managers purchasing equity.
- An ESOP creates broad-based ownership for all eligible employees.
Misconception: ESOPs are only for large companies.
- In reality, many ESOPs exist in companies with fewer than 100 employees.
- What matters is profitability, stable operations, and a long-term outlook.
ESOP vs. Profit Sharing:
- ESOPs give actual ownership, not just bonuses or profit-based distributions.

Tips for Applying ESOPs in a Real Business

If you're considering an ESOP as part of your exit strategy:

Start with a feasibility study. Not every business qualifies—look at profitability, debt capacity, and leadership depth.
Get a valuation. This determines how much the ESOP can pay for the shares.
Build an advisory team. You’ll need a valuation expert, ESOP attorney, third-party administrator (TPA), and CPA.
Educate your employees. Help your team understand how the ESOP works and why it benefits them.

💡 Pro tip: Many ESOPs are financed using bank loans, seller financing, or both—creating flexible options for the owner and company.

Final Thoughts

ESOPs are one of the most powerful—but misunderstood—exit options available to small business owners. They allow you to sell on your terms, reward the team who helped build your business, and preserve your company’s legacy.

Want to explore whether an ESOP could work for your exit strategy? Visit our Exit Planning page to learn more and get expert guidance tailored to your business.