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Get Your ESOP to the Finish Line in 5 Steps

June 5, 2017

Upon making the decision to move forward with an ESOP, you may think the battle is half won. However, this isn’t exactly the case; instead, the hard part is just beginning.

Determining the value of an ESOP to your business is certainly a good first step, but making it from conception to reality will take some logistical maneuvering. Here’s what you’ll need to get your ESOP to the finish line in five simple steps.

1. Examine Feasibility

Deciding to start an ESOP is all fine and well, but determining feasibility is an important part of moving forward. This process can be as in-depth as a full-blown analysis by an outside professional or as minor as an internal review on points like cash flow and debt to income ratio, but the more you can do, the better. An ESOP isn’t a decision to make in haste, so be sure a plan is indisputably the right choice for your business before moving forward.


2. Secure a Valuation

Taking a quick look at your income statements and balance sheets isn’t going to be enough for a legitimate valuation. In order to comply with requirements by the Department of Labor and the Internal Revenue Service, an independent third-party valuation is essential. Some companies choose to first perform a preliminary valuation to confirm that an investment into a full-blown valuation is worthwhile, but no matter which path you choose, you need an unbiased resource.


3. Hire an Attorney

Unless you intend to draft plan paperwork yourself (never a good idea!), an attorney is a necessary part of this process. Choose someone with extensive experience in ESOP establishment and management, and make sure they can advise you properly. The attorney you choose can also help guide you through ensuring everything from employee eligibility to vesting schedules are in line with the law, giving you a reliable way to make sure your ESOP is set up by the book.


4. Obtain Funding

Owners don’t just transfer stock to an ESOP plan; instead, the ESOP needs to purchase stock from the current owners. Unless your company is flush with excess cash, an outside funding source will likely be necessary. A bank loan is the most common way to obtain funding, but plans can also be pre-funded, allowing the Plan to accumulate a certain level of cash to be used when the owner is ready to sell and allowing for a smaller amount of debt to fund the transaction.   This can be slow going but may save money on interest payments over time, especially if current owners aren't in any hurry.


5. Select a Trustee

The trustee you choose can have a significant impact on the effectiveness and legality of an ESOP plan. While many private companies choose an existing team member to serve as trustee, some private and virtually all public companies select an outside individual to avoid conflicts of interest. The trustee exists to operate on the behalf of all plan participants, so be sure to choose someone that has employee interests at heart.

At this point, you have done the necessary due diligence, prepared the proper paperwork, and put the ESOP structure into place. The only thing left to do is fund your plan and begin employee distributions. How you do this will relate to the establishment of the plan, but will likely happen on an annual basis for qualifying employees.

Setting up an ESOP can be a long process, but it’s important to move slowly and deliberately in order to avoid the possibility of critical errors. With these steps, you can be sure you’re on the road to success.

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Gary Canon

Written by Gary Canon

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