A business succession option gaining traction in today’s climate is the Employee Stock Ownership Plan (ESOP). A strategy that allows business owners to sell their companies to their employees, ESOPs offer unique advantages: boosting company culture and employee engagement, while also providing a positive succession plan for owners looking to retire.

Ben Mast, chief financial officer (CFO) of Case IH dealer Birkey's Farm Store, says that 250-300 new ESOPs are being created annually in the U.S., and even more businesses are being acquired by existing ESOPs. He shares his honest thoughts based on real experience into the ESOP transition process, which Birkey’s fully completed in December 2021. Now in  its third year, he says that they’ve learned a lot about not only the intricacies of transitioning to an ESOP, but what the company culture looks like after the process is complete.

ESOPS: A Win for Employees & Companies

Today Birkey’s has 19 Case IH Ag and Construction Equipment dealerships in Illinois with one of those in Indiana, and another in eastern Missouri. 2024 marked  the company’s 70th anniversary, and more than 500 employees are now owners of this long-standing — and successful — legacy business.

Reflecting on the company’s successful transition to 100% employee ownership, Mast highlights both the benefits and challenges of ESOPs. He emphasizes that they can provide a viable solution for business owners seeking to preserve their legacy while empowering employees to shape the company’s future. Former CEO Mike Hedge previously explained that Birkey’s never had a majority owner, making it essential to explore alternatives for long-term sustainability.

“Studies prove that ESOP-owned companies perform better, not only from a profitability standpoint, but from an employee growth standpoint, in terms of longevity and loyalty within the company, as well as those employee owners having a higher household net worth based on their participation in the ESOP,” says Mast.

Tax advantages are another significant benefit. He explains that 100% ESOP S-corporations are exempt from income taxes. There are also a variety of benefits for C-corporations, such as deferring tax on capital gains from selling stock, deducting cash dividends on ESOP-held stock, and more.

All of these benefits truly align employees with Birkey's definition of success, Mast explains. Notably, the positive reactions to the ESOP move have also contributed to lower turnover rates, and provided a competitive advantage in the hiring process.

“When you can take that employee ownership mindset beyond just the management team and spread it throughout the organization, everybody gets going in the same direction, wanting to do their best to improve the profitability and the efficiency of the company,” Mast offers as a lesson learned. “It's a huge advantage.”

The Process Toward an ESOP: How It Works

Mast laid out several key steps dealers would be wise to take in establishing an ESOP.

First: Build the Timeline & Team

Identify your timeline. Mast tells people to not think this will happen in 3-4 months. In order for it to be a comfortable process, with enough time to allow due diligence (especially in identifying external partners), he says at least a year is needed to research and roll out an ESOP program.

Next, building an ESOP requires thoughtful planning. One of the first things to know is that compliance with ERISA and Internal Revenue regulations isn’t optional — it’s essential. “Because you’ve got a trustee and it follows those guidelines, there’s a fiduciary responsibility to act in the best interest of those participants,” Mast explains. That’s why having a specialized ESOP legal counsel on your team is so important. They’ll make sure everything is set up correctly, from valuation rules to ensuring employees receive the value they deserve when they exit. Mast advises that it’s also critical businesses owners take time to “get educated on everything ESOP” and suggests resources like the National Center for Employee Ownership (NCEO) for helpful information.

Building the right team is crucial. Mast emphasizes the need for experienced advisors, including a valuation expert, legal counsel and trustees who understand the nuances of ESOPs. Internally, having a project lead to manage communication and keep things on track is equally important. Governance is another area that often changes with an ESOP.

“Your trustee’s probably going to recommend that you get some formalized committees in place,” Mast shares. Birkey’s added an ESOP administrative committee, an audit committee and a compensation committee, each with 3 members, to handle key organizational needs.

Another big adjustment? Bringing on independent board members. “This can be a little uncomfortable if you’re a family-owned business,” he admits, “but we found it to be very valuable.” For Birkey’s, external board members brought fresh perspectives, including insights into global markets and accounting expertise.

Second: Creating the Trust & Funding

Companies create a separate entity (ESOP trust) that holds the stock on behalf of employees, and is governed by the external trustee. The ESOP trust may involve internal loans (leveraged ESOPs) to fund the purchase, which are paid off over time, releasing stock to employees.

Birkey’s works with an external trustee called TI Trust, which specializes in ESOPs. Mast says most advisors he’s spoken with do recommend using a third-party external trustee vs. an internal one, if for no other reason than because it brings validity and independence.

Third: Valuation Process & Stock Allocation

Independent valuation experts determine the price of shares. “The value of those former shareholders is going to be determined based on an evaluation,” Mast explains. “It's from a financial buyer perspective, not strategic or synergistic.”

The ESOP is based on compensation, with shares allocated based on employees' individual compensation as a percentage of the total. “We really haven't had anybody question that or challenge us on it,” he adds, and further notes that part of the trustee’s job is to complete a variety of ESOP compliance tests. One of those is to ensure that “top-heavy” compensation is not violated.

Annual valuations ensure the stock price is updated each year, based on business performance.

Fourth: Employee Participation & Vesting

Employees become eligible to join the ESOP after reaching age 21 and completing 1,000 hours of service, entering the plan at the start of the following year. Vesting schedules can vary, either using a cliff or graded approach, but full vesting typically occurs at retirement. Once fully vested, employees can access the value of their stock after qualifying events like retirement, disability, or termination.

A unique way to engage employees in the ESOP is through an "ESOP Champions" program. Birkey’s  selects one or two passionate employees from each location — rank-and-file workers, not just managers — to serve as advocates for the plan. These champions meet monthly with leadership, such as Chief Executive Officer (CEO) Brady Foster, to discuss ESOP updates and other important organizational news. They then share this information through meetings at their locations, fostering communication and engagement.

Celebrating ESOP milestones, like the annual stock valuation, has also been impactful. “Every year, we go out to all locations, give a little presentation, hand out participant statements, and express our appreciation,” Mast says. These moments have built excitement and appreciation for the ESOP across the organization. He again recommends resources like the NCEO for anyone looking to learn more about these helpful ideas around starting or managing an ESOP.

Challenges & Considerations

The ESOP process is complex. Mast says any business owner must go into it understanding that it will require careful planning and working with external partners mentioned before, such as ESOP-familiar legal and accounting teams.

Another challenge is that transaction costs can be significant, and sellers will potentially take on debt. “If you’re not working with somebody who  really knows ESOPs well, it could lead to confusion,” Mast advises. “You’re going to have to get legal involved. But I guess I would argue that, no matter what route you take to sell your business, it’s going to be challenging. But if you’ve got the right partners in place, it’s not anything that can’t be overcome.”

Still, an ESOP offers a lot of flexibility for both business owners and employees, making it a unique way to transition ownership while preserving the company’s culture. As Mast explains, “Some people will do it 100% right up front and exit the business, or just kind of remain on in a management capacity for a period of time. But some want to do it gradually, and you have that flexibility with the ESOP.”

From the employee perspective, ESOPs are governed by clear participation and vesting rules. Shares are released annually based on an internal loan, and the timeline for that loan is key. Mast says, “We structured ours over a 40-year period of time. If you make it too short, it really takes the advantages away. A 5-year window doesn’t keep that culture and commitment to growth going much beyond that for new employees.”

When employees leave the company, they’ll naturally want to know when they’ll get paid for their stock. Mast explains, “That’s covered by distribution rules. It’s either when you reach retirement, or in cases of death or disability. If you leave the company for another reason, there’s a delay until the seller's debt is paid off — maybe 5 or 8 years — and then payouts usually happen over five years.” This structure ensures the ESOP remains financially sustainable while offering employees fair value over time. “It’s a way to ensure everyone benefits and keeps the long-term culture intact,” Mast adds.

This, he explains, is why employee communication and education is critical, and can become the biggest challenge if not handled properly from the beginning.

“The ESOP is all about growing the value of the business, which is going to benefit everybody in the long run, but with any kind of transition like this, you're going to have some employees that are skeptics and thinking maybe you're doing it for the wrong reasons,” Mast explains.

He says that is even more reason for management to be strategically prepared to communicate a common message to employees, sharinghare with them why the ESOP route was taken, what it can do for them, and also what it means for them in the long run.

Leaving A Business Legacy

Despite market fluctuations, ESOPs continue to be a beneficial option for business owners looking for a way to transition but also to increase employee engagement. Mast says he would do it again, even with market challenges. A change in ownership disrupts employees, but also local communities.

For Birkey’s, the ESOP decision provided a way for owners to secure their company’s legacy while providing a new level of culture and ownership mentality for employees. From improving company performance to offering substantial tax benefits, the advantages of an ESOP will have a lasting impact on both the business and its workforce. “We had a real strong desire to  keep the company legacy in place …  and reward the employees that helped us get here,” Mast says.

As the ESOP experience at Birkey's illustrates, the process of transitioning to employee ownership requires careful planning, communication, and dedication — but the rewards are well worth the effort.