Who this suits
An ESOP suits an owner who cares about what happens to the company and its people after the sale, who has a capable management team ready to run the business, and who is comfortable being paid over time. The company needs steady, predictable profits to repay the money used to buy the shares, and a payroll large enough to support the plan.
It suits less well if you want the highest possible price and all of it at closing, if profits are volatile, or if the business has no clear leadership beyond you.
How it works
- The company sets up an ESOP trust, overseen by an independent trustee who acts for the employees.
- An independent appraiser values the shares. The ESOP can pay no more than fair market value.
- The ESOP buys your shares, usually with money the company borrows from a bank plus a loan from you (a seller note). Employees pay nothing for their shares.
- The company makes tax-deductible contributions to the ESOP each year, which the trust uses to repay the loans.
- Shares are allocated to employees' accounts as the loans are repaid, typically in proportion to pay, and vest over several years.
- When employees retire or leave, the company buys back their vested shares at the then-current value. This is the repurchase obligation, and it lasts as long as the ESOP does.
You can sell 100% at once, or start with a minority stake (30% or more matters for tax, see below) and sell the rest later.
A worked example
Our illustrative company is an Ohio precision fabricator, an S corporation with $4.0 million of EBITDA, appraised at $24 million. The owner sells 100% to an ESOP. A bank lends $10 million; the owner lends the remaining $14 million as a seller note, repaid over eight years with interest, plus warrants that give him a share of any increase in the company's value while the note is outstanding.
| Amount | When | |
|---|---|---|
| Cash at closing (from the bank loan) | $10.0m | At closing |
| Seller note principal | $14.0m | Over about eight years, once the bank is largely repaid |
| Interest on the seller note | Several million dollars | Over the life of the note |
| Warrants | Depends on how the company performs | Typically when the note is repaid |
Because the company is an S corporation owned 100% by an ESOP, it pays no federal income tax on its profits. All of its cash flow can go to repaying the loans, which is what makes this structure work. Figures are illustrative; the actual split between bank debt and seller note depends on the company's cash flow and the lender.
Compared with a $24 million sale to private equity with $21.6 million in cash at closing, the owner here takes far less at closing and carries the risk of being repaid. In return he keeps the company independent, rewards the people who built it, earns interest and warrant upside, and may benefit from the tax rules below.
Wondering whether an ESOP or a sale would leave you and your people better off? Let's compare them on real numbers.
Book a confidential callTax benefits and the rules that apply
This is not tax advice. These are the points to take to a tax advisor who works on ESOPs.
For the company
- Contributions used to repay the ESOP loan, principal and interest, are generally tax-deductible, within limits linked to payroll.
- S corporations: the share of profits owned by the ESOP is not subject to federal income tax. A 100% ESOP-owned S corporation pays no federal income tax at all. Anti-abuse rules (Section 409(p)) apply to stop the benefit being concentrated among a few people.
For the selling owner: Section 1042
- If the company is a C corporation, the ESOP owns at least 30% after the sale, and you have held the shares for at least three years, you can defer capital gains tax by reinvesting the proceeds in stocks and bonds of US operating companies within a window running from three months before to twelve months after the sale.
- Your original tax basis carries over to the new investments; tax is due when you sell them. If you hold them until death, the gain may never be taxed under current law.
- Shares sold under Section 1042 cannot be allocated to you, your close family or other large shareholders inside the ESOP.
For S corporation owners from 2028
- Under the SECURE 2.0 Act, S corporation owners selling to an ESOP will be able to defer tax on 10% of their gain for sales from 2028. A bill in Congress would extend this further; it has not been enacted as of this guide's last review.
Valuation rules (October 2026)
- The Retire Through Ownership Act, signed in October 2026, lets ESOP trustees rely in good faith on the long-standing IRS valuation principles (Revenue Ruling 59-60) when setting fair market value. The aim is to reduce disputes over the price an ESOP pays.
What you give up, and what it costs
- Price: an ESOP pays fair market value as set by the appraiser. It will rarely match a corporate buyer paying extra for cost savings.
- Timing: much of the price is usually paid over years, not at closing, and depends on the company performing.
- Cost: setting up an ESOP needs an appraiser, an independent trustee, lawyers and often a lender, a meaningful six-figure cost for a company this size, plus annual valuation and administration.
- Repurchase obligation: buying back shares from departing employees is a permanent cash commitment the company must plan for.
- Governance: you can stay as CEO and on the board, but the trustee represents the employees as shareholders and has a duty to them, not to you.
How ExitBuy helps
An ESOP is one route among several, and the right choice depends on comparing it honestly with the alternatives. We start by estimating what your company would fetch from private equity or a corporate buyer, so you know what an ESOP's fair-market price and payment terms really cost you. If an ESOP is the right fit, we bring in specialist ESOP lawyers, trustees and lenders, help negotiate the seller note and warrant terms, and coordinate the process. Some owners run both in parallel and decide at the end.
Frequently asked questions
Do employees have to pay for their shares?
No. Shares are bought with company-funded loans and allocated to employees' retirement accounts over time.
Can I stay in charge after selling to an ESOP?
Yes. Many owners stay as CEO or chair for several years. Day-to-day management does not change; the trustee votes the shares on major decisions.
Is an ESOP only for very large companies?
No, but the company needs steady profits and enough payroll to support the plan. It is usually a fit for companies with several dozen employees or more.
Can I sell only part of my company to an ESOP?
Yes. Many owners sell 30% or more first, which can qualify for Section 1042 in a C corporation, and sell the rest later.
How long does it take?
Usually several months, depending on the valuation, financing and trustee review.
What happens if the company struggles after the sale?
Repayment of the bank loan comes first, then your seller note. Weak performance can delay your payments, which is why the size of the seller note matters.
Mauro Terrinoni, CFA, founder of ExitBuy Co. 25 years in investment banking and private equity, including at JP Morgan, Citigroup and Fortress Investment Group, and has bought, run and sold a company as its owner.
General information only, not investment, legal or tax advice. Figures are illustrative. Tax rules change; confirm current law with your own advisors.
Sources: NCEO, Federal legislation on employee ownership · RSM, FAQ on Section 1042 tax deferral · NCEO, Will the Retire Through Ownership Act reduce ESOP fiduciary risk? (October 2026)