Succession Planning Considerations: Is an ESOP the Right Solution for Your Business?

What Is an ESOP?

An Employee Stock Ownership Plan (ESOP) is a qualified retirement plan that invests primarily in the sponsoring company’s stock. Through an ESOP, employees become beneficial owners of the business over time, while the selling owner(s) can achieve liquidity, potentially with significant tax advantages.

Benefits of an ESOP

An ESOP offers several compelling advantages for business owners considering their exit planning options.

• Transferring ownership to employees rather than an outside buyer can help to preserve the business’s culture, mission, and local roots.
• ESOPs can provide significant tax benefits for the right business.
• ESOPs can boost employee motivation and retention—employee-owners tend to be more engaged and committed to the company’s success.
• An ESOP can be designed to support a gradual ownership transition, giving the departing owner time to mentor successors and ensure continuity in leadership.

Important Considerations

While ESOPs offer many advantages, they are not the right fit for every business. Companies need stable cash flow, a capable management team, and typically at least 20 to 30 employees to make an ESOP viable. The setup and ongoing administration can be complex and costly, involving legal, financial, and regulatory oversight. In addition, once an ESOP is in place, the company and its leaders take on fiduciary responsibilities to act in the best interest of employee-owners, which adds an extra layer of accountability. Financing the transaction is another key consideration, as the company usually needs to borrow or take on debt to fund the purchase of shares. Business owners must ensure the financial strength and resilience of the company to support this structure over time.

Is an ESOP Right for Your Business?

Ask yourself:

• Do I want to reward employees and secure the legacy of my business?
• Is there a strong leadership team ready to take over?
• Can my business support the financial structure of an ESOP?

If you answered yes to most of these questions, an ESOP might be a viable option as part of your succession planning strategy.

Choosing the right succession path is a deeply personal and strategic decision. An ESOP offers a compelling alternative to traditional sales, especially for owners who value legacy, employee welfare, and long-term independence. However, it’s not without challenges.

Business owners should work with experienced legal, financial, and ESOP advisors to fully explore this option.

How We Can Help You

Davis & Hodgdon CPAs supports business owners as they consider an ESOP as an exit strategy in many ways:

• Feasibility Assessment Support. We analyze cash flow & financials to determine whether the company can support the costs of an ESOP, including:
  • Loan repayments (if leveraged)
  • Future repurchase obligations
  • Employee benefit costs
• Work with valuation experts and advisors to review the pros and cons of various scenarios.

Why this matters: Not all companies can sustain the financial and operational demands of an ESOP—CPAs help owners see the numbers clearly.

• Tax Planning & Strategy. Evaluate the tax advantages for both the owner and the business.
  • Assess entity structure and evaluate the most tax-efficient way to structure the ESOP (e.g., C-corp vs. S-corp considerations).
  • Review potential impact on personal and business tax returns.

Why this matters: ESOPs can offer major tax benefits, however entity structure plays an important role in what tax benefits may be available. What benefits the owner(s) may not lead to the greatest short-term benefits for the business, so it is important to make sure that everyone is aligned on strategy.

• Financial Due Diligence & Deal Support.
  • Clean up financial statements and ensure GAAP compliance for valuation and lender requirements.
  • Assist with pre-transaction financial prep—normalizing EBITDA, removing owner perks, clarifying balance sheet.
  • Collaborate with the valuation firm and ESOP trustee on financial documentation.

• Audit & Reporting Post ESOP.
  • Provide annual financial statement audits or reviews, which are often required by lenders or trustees.
  • Ensure ESOP-related financial disclosures are properly included.
  • Assist with ESOP repurchase obligation forecasting and planning.

• Business Owner Personal Financial Planning
  • Davis & Hodgdon offers wealth management and estate planning services, helping the owner:
    • Understand the after-tax consequences of selling to an ESOP.
    • Optimize charitable giving, trusts, or wealth transfer strategies tied to the sale.

Are you a business owner ready to consider an ESOP as part of your succession plan?