By Kyla Hansen, CPA, CVA
An employee stock ownership plan (ESOP) can be a great way to transition your business and give back to your employees. But it’s not ideal for everyone. Before you move forward with an ESOP, it’s wise to do your homework and make sure it’s right for you. (This is partly because becoming an ESOP is not cheap!) Here’s how an ESOP feasibility study can help.
What is an ESOP feasibility study?
Simply put, an ESOP feasibility study evaluates certain metrics and aspects of your business to determine if becoming an ESOP makes sense. The study allows you to know if becoming an ESOP is not only feasible but also in line with your goals—before you get too far into the process.
Phase 1 of an ESOP feasibility study focuses on the following:
- Number of employees on your payroll. Typically, you’ll need to have at least 20 employees to become an ESOP.
- Your earnings with interest, taxes, depreciation, and amortization added back in (EBITDA). Ideally, your business should have an EBITDA of at least $250,000.
- High-level analysis to determine your business’ estimated value.
- The strength of your management team.
- Your goals for the transition.
If, after this initial assessment, you decide to continue on the ESOP path, Phase 2 of the study would focus on the following:
- An in-depth analysis of the value of your company
- An analysis of the employee benefit levels needed to support the ESOP (IRS retirement plan limits apply)
- Determining the structure of the transaction
- Financing considerations
- A cash flow analysis of your company
- After-tax cash flows to seller
- Reviewing your team of advisors and making changes if needed
An ESOP isn’t your only option.
If an ESOP isn’t ideal for your business, consider an alternative solution. Two that also allow you to give back to employees are a worker co-op and an employee ownership trust (EOT).
Look before you leap.
As I mentioned, it’s wise to make sure an ESOP is right for you before jumping headlong into the process. Becoming an ESOP requires assistance from a variety of professional advisors—and their fees can quickly add up. If you’re thinking about selling your business and would like to give back to your employees, an ESOP feasibility study can help you explore your options.
At JAK, we can provide you with everything from an initial assessment to a full-blown feasibility study. As one of the founding members of the Minnesota Center for Employee Ownership (MNCEO), we can help you weigh the pros and cons of becoming an ESOP and, if necessary, connect you to professionals who can guide you through the process. To learn more, contact us today.