ESOP Boot Camp, Part 1: What Is an ESOP? How Employee Ownership Actually Works

What exactly is an Employee Stock Ownership Plan—and how does it actually work?

In this episode of ESOP Radio, Trevor Gilmore, CEO of Menke, and Ben Spadt, ESOP Investment Banking Consultant at Menke, kick off the ESOP Boot Camp series with a plain-English explanation of employee ownership.

The conversation breaks down what an ESOP is, how it functions as a qualified retirement plan, and how it differs from mergers and acquisitions, private equity, or gifting stock to employees. Trevor and Ben also explain how ESOPs are financed, how fair market value applies, why ESOPs exist in the first place, and the role employee ownership plays in succession, liquidity, and long-term company independence.

This episode is designed for business owners, CEOs, CFOs, and advisors who want a clear, straightforward understanding of ESOP fundamentals before exploring feasibility or transaction structure.

ESOP Radio is the official ESOP podcast from Menke, where real stories of growth, succession, and long-term wealth building are told.

⚠️ This podcast is provided for educational purposes only and does not constitute legal, tax, investment, or fiduciary advice.

Learn more:

• ESOP Radio: https://www.menke.com/esop-radio/
• ESOP Boot Camp: https://www.menke.com/esop-boot-camp/
• Confidential feasibility review: https://www.menke.com

Transcript

0:03

Hi everyone, welcome to ESOP Radio. Thanks for joining episode one of the Esop Boot Camp. Our goal is to give you the owner, CEO, or CFO of a successful business. The lowdown on Esops in a quick, straightforward method because your time is valuable. I'm Trevor Gilmore, CEO of Menke. And I'm Ben Spadt. Investment banking with Menke. Since 1974, Menke has been a full service Esop advisor. And we've seen it all from, you know, capital raisings to structuring esops, regulatory compliance to calculations of value and mergers and acquisitions. We've created thousands of esops. And as an Esop ourselves, we're Esop native. Our first episode. What is an Esop? Well, demystify what this four letter acronym really is. And guess what? It's not Aesop's Fables. We will answer three questions a day. Number one, what is an Esop? Number two, how do Esops differ from M&A, meaning mergers and acquisitions and private equity? And number three, why do Esops exist in the first place? All right, Ben, let's dive in. Absolutely. So first and foremost, you know, let's define Esop. The letters Esop stands for employee stock ownership plan. And in essence, it's a qualified retirement plan much like a 401 K. So the IRS and the Department of Labor, keep tabs on on what's happening with that plan. In 1974, under a Rissa which governs all retirement plans, a law was created that made, modern U.S. retirement plans legal. So the 401 K, for instance, and Esops, Esops are essentially an owner of the company. It's a trust that, acts on behalf of the individuals or the employees in, in the plan. And it can own anywhere from 1% to 100% of the company. We've seen them all across the board. They are a fair market value buyer of the company. And by fair market value, we mean the IRS definition, which means willing and able buyer, willing and able seller that negotiate for a price based on financial fundamentals. In other words, it's rooted in reality. Sometimes you'll read in the paper people, companies buying companies for a ten x multiple or 12 x multiple. Those are more strategic buyers. And, you know, fair market value is a component of that. But they're saying you're worth extra because of some strategic, objective. So esops buy at fair market value. And it's really the only qualified retirement plan that can be leveraged or can borrow money. And that's where the fun begins. Really. So with that, the esops can be used to cash out owners of small to medium sized companies. Think roughly around 30 plus employees. We have clients that have, you know, that 30 employee threshold all the way up to 10,000. And so that's Esop in a nutshell. But, Trevor, do you want to talk about how esops differ from things like M&A. They expand? Yeah. And definitely more on value later for sure. A lot to uncover there. You'll see in a future episode we'll cover cash flows and, you know, value and all that good stuff. I'll now cover how Esops differ from M&A, private equity or gifting stock. There's eight key points here. Number one, Esops are a buyer of your company. Number two, so are acquirers including private equity. So when I mean acquirers I mean it could be a competitor. It could be a private equity firm. It could be in a, company that is in a completely different industry but wants exposure to you. Your brand and your clients. So the Esau fits into that category as an acquirer. Number three Esops allow the company to remain independent and reward employees. Compare that to M&A or private equity. If you go down either those routes, meaning M&A or private equity, your company will not remain independent as it is today. That is a big distinction. The question to answer, which we like to ask, all of our prospects here. Is your company better off independent or part of a bigger player? Do you have a large moat? If the answer is yes, an Esop might be compelling. Number four, how could in Esop buy my company? And the answer has been alluded to earlier is leverage. Technically, the company's cash flows are used to guarantee the Esop. And that's how the whole Esop thing works. Think company cash flows at both times. The value it ties to making the whole thing work. There are two main financing options out there for Esops, which is bank or seller financing. And that's very similar to what we see in the M&A and private equity world. And we'll cover those in a future episode. Number five, Esops usually have more tax benefits than a third party sell. The ability for the seller to defer capital gains permanently and for the company to operate tax free. So those are two big things that are unique to Esops. We'll cover this in a future episode as well. And number six, you can see involved with the company after selling to an Esop. So we see this with our client base, founder or maybe it's the second or third generation owner and so on. Wants some liquidity. We set up the SOP, make the whole thing happen, and they're still acting as the CEO of the company and probably on the board as well as there's no requirement that you must exit. If you compare that to a third party SEL, meaning it mergers, acquisitions or private equity, you will likely one out after a few months because you have a new overlord in essence, that is dictating a lot of things. Company is not independent anymore. So you talk to friends, you know, out there who have gone down that path and more often than not, they will tell you, hey, I stuck around for the minimum amount of time to get my earnout and then I was done. Esop is not going to have that same outcome. A lot of flexibility there. And number seven, one recent trend we're seeing is a structure where esops come in and buy a minority stake, meaning less than 50% in a private equity firm or a family office, which basically is a family that has a ton of money and, creates a and investment arm with professionals that basically go out and buy companies according to their family's investment thesis, buying the controlling stake. So we are seeing more of these hybrid. So it's not either or. Whereas the prior points were kind of saying either or we are seeing this hybrid or we have an Esop minority shareholder and a control. Interest held by the PE or the family office. And lastly, number eight, do not confuse Esops with gifting stock to employees. Some people say that I'll talk to a prospect and they'll say, oh, if I go Esop, I'm just giving the employees the company, you know, and so on. And that is not, you know, rooted in any sort of reality. Esop is a qualified retirement plan, and employees must work smart and hard to earn it. The stock is allocated over a long period of time in your gifting the stock to the employees. They have to work hard for it and also the future Esop value is reflected in that reality. Yeah. So Ben covered eight points here about the key distinctions between esops, mergers, acquisitions and private equity. It's going to kick it over to you. And you can cover why Esops exists in the first place. Yeah, I love those examples. Those eight points that you made and and truly, you know, Esops exist because retirement plans like the 401 K can buy public company stock or bonds, mutual funds, things like that. But one thing that is excluded are those private company stock, private company shares, private company stock that you alluded to that you know, perhaps family offices want to buy the majority stake, but you can't really, utilize your 41K or something like that to buy companies, private company stock. So why not let them, private companies use a retirement plan to acquire shares of the company, provide some or all liquidity to the owners, and then allow the company to stay independent. So as you alluded to, you know, there's, a competitor's not swooping in and and buying you up and perhaps changing the way you're structure, changing the way you, treat your r a p, switch out your board. You know, things like that, you get to remain independent, remain in control. And so esops, you know, they were a creative solution to that age old problem. Who's going to buy my company? And the answer can be and often is employees. But you know, the rank and file employees can't finance the purchase of the business. And so that's where the Esop comes in, which can buy the, you know, some or all of the company and solve those three things liquidity, succession and motivation. You know, those employees then own the company, in effect. And a lot of times we see that, people treat things that they own better than things that they rent. And, you know, there's often the example of the rental car or renting a home. So, yeah. When was the last time you wash a rental car? That's a unless it was required, I think, sometimes I know they do require, you know, the doesn't, but. Yeah. So prior to Esop, so there was just kind of a little bit of, you know, here and there providing ownership to employees. Trevor. What? I think there's one specific example, but I can't remember right off the top of my head. Yeah. So, you know, you go back way back to the 1950s and this is sort of the the granddaddy of all esops, company was called Peninsula Newspapers on the San Francisco Peninsula, where Silicon Valley is today. I think they're headquartered like, San Mateo, if I recall. Yeah. An attorney called Louis Kelso, based in San Francisco. And he's actually who our founder started as he saw career with our founder, John Menke. They had a client, Peninsula Newspapers, that needed a succession plan. So the overall owner of the company, who had majority control, said, here, we want to sell the company who best us all to but the employees. But the employees don't have their own money. So how can that happen? Answer is an Esop. So that was largely credited with the first Esop out there. And that happened before Esops became legal. For you in the code heads out there, esops became legal. And, what, 1974 Labor Day, 1974. President Ford signed the RSA legislation making them legal along with, for one case, you know, and so on. The modern retirement structure. Yes, they're definitely unique. And, you know, you think retirement plan, this is the only one that can use leverage, meaning it can use leverage in conjunction with the company cash flows to buy the company. Excellent. You know, I forget the details on that, but that was a perfect summation. And, you know, that signing that legislation in 1974 by Gerald Ford was, you know, did start a massive trend, back then and to all the way to today, you know, in a good number of states, there's an employee ownership, either center or organization that helps promote employee ownership and esops, we find that it's a bipartisan tool. There's a lot of good things that are working for us in this industry and also as a succession tool to provide you that liquidity and an exit. Absolutely. You know, you get skin in the game. Guess what? People might have that ownership mentality kick in right now. That's what you want right? You know you don't want hired hands. You don't want someone who doesn't wash a rental car, right? You know, you you want that thing gleaming, right. And performing. Yeah. So that's it for episode one. We covered three key things today. Number one, what is an Esop? Number two, how do Esops differ from M&A in private equity. And number three, why do Esops exist in the first place? Thank you for joining us today. Connect with us on LinkedIn. You can find us, Trevor Gilmore, Ben Speight and also ESOP Radio or our mentee page. And of course, our website, Mediacom has real life case studies of our clients, and we post a lot of Esop news on there as well. Reach out to us to learn more about our Esop fit analysis. That is the first step in assessing if an Esop is right for you. Have an awesome day! Join us for episode two. Is your company a good Esop candidate? Take care everyone. Thank you. Bye bye.