Small Business

Considerng ESOPs Before Private Equity

Don’t sell before you look at both sides of the coin

By Anthony Venette, CPA/ABV, Manger, Corporate Value Consulting at Withum On Aug 29, 2025

Research shows that 85% of all private equity (PE) investments go into small businesses with fewer than 500 employees. And many of the small businesses I work with, who’ve been approached by PE firms, are attracted by the potential for liquidity, access to capital, and the possibility of a “second bite” when they retain rollover equity.

The pitch is polished. Multiples look strong. Closings move quickly. It’s no surprise that many owners see PE as the pinnacle exit.

However, the current small business M&A market is not the same as it was four or five years ago. Capital is more selective, terms are evolving, and post-closing realities can differ greatly from initial expectations. Some of these differences are financial, while others affect company culture and the seller’s personal role.

Before moving forward with PE, make sure you have considered an Employee Stock Ownership Plan (ESOP) as an alternative. ESOPs are not the solution for every situation, but they can offer a distinct set of benefits that align well with certain ownership goals you have.

Where PE May Pose Challenges

For the right company and right ownership objectives, PE can make a lot of sense. For starters, it can bring capital, operational resources, and a defined growth plan. However, owners should remember that PE transactions often include deal structures such as earnouts or rollover equity, which can shift part of the transaction value into the future. Earnout targets may be ambitious and may depend on how the business is managed post-sale. Meanwhile, rollover equity ties the owner’s outcome to a future exit you do not control. Reporting and governance requirements can also increase substantially, which some leadership teams find to be a significant adjustment.

Cultural changes can occur as new strategies are implemented, synergies are sought, and management structures evolve. For some owners, this is an opportunity to accelerate transformation. For others, it may be a less comfortable fit. Understanding how these dynamics could impact your team and your role – in advance of a potential transaction — is essential for determining whether PE is right for you and your company.

What an ESOP Offers Instead

An ESOP is a qualified retirement plan that allows employees to become beneficial owners of the company through a trust. An ESOP is often used in succession planning for closely held businesses with a stable employee base and strong culture. While ESOP transactions have their own complexities, they have many advantages:

In my experience, ESOPs can create liquidity for the owner while allowing for a phased transition of control. Consideration often includes seller notes, which may carry attractive interest rates and can be paid down faster if the company outperforms Projections. Warrants or stock appreciation rights can keep an owner financially involved in the company without the constraints of an earnout. Employee engagement frequently increases as they gain a stake in the Company’s performance and leadership continuity can help preserve the culture.

For example, one ESOP client in a professional services firm saw retention improve in the first year after closing. The seller received a mix of cash and notes with favorable interest, and performance-based acceleration clauses that led to an early payoff. The company maintained its management approach while expanding the sense of ownership across the workforce.

Valuation: Not Just What You Get, But How You Get It

PE buyers often focus on EBITDA multiples when presenting an offer. While the number may appear compelling, the structure can influence the actual proceeds received whether it includes seller financing, earnouts, or working capital adjustments,

An ESOP transaction is based on fair market value as determined by an independent appraiser. The financing is structured to support the company’s operations while servicing the transaction debt. With proper planning, ESOP after-tax proceeds can be competitive with, or exceed, proceeds from a PE sale, especially after factoring in continued control, cultural preservation, and realistic performance incentives.

In one case, a business owner I worked with compared an $80 million PE offer with an ESOP scenario. After adjusting for taxes, earnout considerations, and rollover equity value, the ESOP was projected to deliver approximately $4 million more in certain cash flow to the seller than the PE offer while keeping the leadership team intact.

The Tax Story Owners Wish They Understood Sooner

Under Section 1042 of the Internal Revenue Code, a seller in a C corporation ESOP transaction can roll their proceeds into qualified replacement property and defer capital gains taxes. The company can also deduct the cost of buying out the seller, creating significant tax efficiency. In a PE sale, capital gains taxes are typically due at closing, which can affect net proceeds. This is why it is important to look beyond the headline price and focus on the after-tax outcome when comparing transaction structures.

Conclusion

Numbers tell part of the story, but the intangibles, such as preserving your company’s culture, maintaining stability, and providing employees with a stake in the company’s future, carry equal weight if not more. Make sure you factor in the intangibles, not just the numbers, when determining success factors for your exit.

If you are evaluating a sale, it is worth examining both PE and ESOP options to see which strategy best aligns with your priorities. By understanding both options, you can make a decision that balances financial results with your vision for your company’s next chapter.

Withum’s Corporate Value Consulting team and ERISA specialists have extensive experience structuring, valuing, and executing ESOP transactions for companies across a variety of industries. We can help you model an ESOP alongside a PE offer so you can make a fully informed choice about your future.

Your exit is likely the largest financial decision of your life. Make sure you’ve looked at every angle.

Anthony Venette, CPA/ABV is a Manger, Corporate Value Consulting at Withum.

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