Authored By: Patrick Guthrie, CFA
When business owners begin exploring exit strategies or liquidity events, the idea of selling to an Employee Stock Ownership Plan (ESOP) often surfaces as one of several options. Assessing whether an ESOP is the right financial and strategic fit for both the company and its owner requires a thorough, data-driven analysis. That’s where a feasibility study comes in.
This essential analysis is often the first step before an ESOP conversation can begin in earnest. It gives owners and management clarity, advisors direction, and sets the foundation for any future transaction.
Why Start with a Feasibility Study?
Owners considering an ESOP are usually weighing multiple exit strategies: a third-party sale, a transition to a family member, a management buyout, or an ESOP. The feasibility study identifies whether an ESOP is viable and provides a foundation to compare to other exit options.
It answers a fundamental question: Given our current and projected cash flows, can this company support an ESOP transaction?
Before hiring a trustee or negotiating with a bank, advisors and bankers alike will recommend—if not insist—that the company start with a feasibility study.
What a Feasibility Study Evaluates
While the word “feasibility” suggests a simple yes/no answer, the analysis dives far deeper. It examines not just whether an ESOP can be done, but how it might be structured, the benefits and risks involved, and whether the business can support it over time.
1
Financial Feasibility
The first and most fundamental question is whether the company’s cash flow can support the transaction. This includes a detailed review of current financial performance and future projections. The goal is to determine whether the company generates enough earnings to repay any debt used to fund the ESOP and still maintain healthy operations.
2
Tax Benefit Analysis
A key motivator behind many ESOP transactions is the favorable tax treatment they can offer. But the level of benefit depends heavily on how the company is structured—whether it’s an S-Corporation or C-Corporation—and how the transaction is designed. The feasibility study analyzes various tax scenarios for both the seller and the company, identifying which structure delivers the highest tax savings and how to optimize the outcome for the buyer and seller.
3
Transaction Structuring
There are many ways to finance an ESOP, from bank debt to seller notes and warrants. The feasibility study models different structuring options: How much external financing will be needed? Will the seller hold a note, and what are the repayment terms? Are equity warrants or stock appreciation rights (SARS) appropriate? These variables are tested across multiple scenarios to understand the receipt of cash to seller and impact and fairness of other forms of consideration as well as the impact on the company’s long-term cash flows.
4
Long-Term Sustainability
An ESOP doesn’t end after the transaction closes. Over time, the company must be able to issue shares to employees and eventually buy them back as employees retire or exit. The feasibility study ensures that the company can manage and sustain these obligations, so it’s not just feasible at the start, but also viable in the long run.
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What Happens After Feasibility?
If the results are favorable, the owner can move forward with:
- Retaining a trustee to represent the ESOP in the transaction.
- Securing financing through banks or seller financing arrangements.
If the study reveals that an ESOP isn’t financially or operationally feasible—or that a third-party sale would result in greater value—the owner can pivot with confidence, having made an informed decision backed by objective data.
Common Questions & Considerations
Q: Who typically brings up the feasibility study?
Feasibility studies are often brought up after an owner speaks with a peer, banker, or trustee. Trusted referrals—especially from those who’ve completed ESOPs themselves—are common entry points.
Q: Is an ESOP always the goal?
Not necessarily. Sometimes the feasibility study shows that an ESOP isn’t the most financially sound option. In other cases, a third-party sale may offer better value. The study helps owners evaluate these paths objectively.
Q: How long does the study take?
It varies depending on the company’s size and complexity. A feasibility study involves detailed modeling, tax analysis, and scenario planning, and typically takes several weeks to complete.The company-specific risk premium (CSRP)—historically viewed as a subjective “fudge factor”—is under increased scrutiny. Regulators and auditors now expect stronger quantitative support.
Making the Right Call Starts with the Right Questions
A feasibility study isn’t just a box to check. It’s a comprehensive analysis that prepares business owners for one of the most important decisions they’ll ever make. From understanding cash flow and tax impact to navigating deal structure and long-term obligations, the feasibility process brings clarity to complexity—and helps ensure that any ESOP is being pursued for the right reasons.
If you’re considering an ESOP or exploring your succession planning options, the Evergreen Advisors Business Valuation team is here to help. Reach out to our team with questions or to start a conversation about whether a feasibility study makes sense for your company.
