Is Your Company Ready for a Sale or an ESOP? 2026 Update

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If you were to ask an owner what was their most valued asset, the likely answer will often be their business. The challenge that they deal with is usually not whether to sell, but how to sell. For most companies, the choice comes down to two fundamentally different paths: a third‑party sale, where control transfers to an external buyer or an ESOP, a regulated, valuation‑driven structure under the the Employee Retirement Income Security Act of 1974 (ERISA) that allows owners to sell at fair market value while transitioning ownership to employees.

Understanding the differences between these two exit strategies is essential for determining which path preserves the business, the culture and the owner’s financial objectives. This article focuses on preparing for a successful exit strategy through the sale of the business to a third party or an employee stock ownership plan (ESOP). Whether the business is ready for a third-party sale or sale to an ESOP, proper planning and preparation is necessary in both scenarios.

Proper Planning for a Sale

Business owners deserve to receive a fair market price for the business that they have worked so hard to create, develop and grow (often with the same level of care and commitment one would devote to their child). Their company will often represent their largest asset. Preparation of a business before the sale is a crucial step in maximizing its value and ensuring a smooth transition for both the seller and the buyer. When proper planning is absent, a sale can become forced (especially in a death, disability or family dispute situation). In a forced sale, the seller has little to no bargaining power and will likely receive a far less favorable price once the sale is final.

Business owners may (unknowingly) be putting their company’s value at risk, if they rely entirely on the sale of their business, as their exit plan and their succession strategy without first doing any proper preparation. Prior to deciding to sell a company, succession planning should be a implemented to be able to sustain a business’ profitability and retain its value. When a business is being prepared for a sale, certain strategic changes can possibly create value for a sale. Effective succession planning is equivalent to a realtor staging a house before it goes to market; it protects value, piques interest and accelerates sales.

Competent CEO/CFO Successor

An important factor in choosing to sell a business or continuing a family business is whether there is a competent successor CEO, CFO or management team to run the business. This can have a dramatic impact on value regardless of whether the sale is to a third party or an ESOP. Buyers within the industry may be indifferent about many things, but will often want the owner or the management team to stay on for a certain transitional period (via a retention plan).

The decision to sell often incorporates several personal, business and economic factors. An owner may be in bad health, experiencing burnout, interested in pursuing other ambitions or aiming to diversify his or her wealth, when contemplating selling or retirement. In some cases, business owners are approached with attractive, difficult to refuse offers from outside buyers. Contract renewals, product or service launches, expected industry changes and technological developments may also influence the sale of or retirement from, a business. Current demand and heightened valuation multiples may also entice business owners to sell. Regardless, being ready and adequately prepared for a sale can make it easier for potential buyers to assess your company and maximize value.

Requirements for a Potential Sale

A potential buyer will (at minimum) require two years of historical financial statements, including the interim financials for the current year of sale. Buyers would also like to see realistic financial statement projections going forward for five to 10 years. The more organized and accurate the accounting records, the easier it is for potential buyers to assess your company’s value. Accurate accounting data can help identify trends in your business and can be used to maximize profitability. To ensure accounting data is accurate, accounting processes must be consistent.

A compilation, a review or an audit may be conducted to provide reasonable assurance to a buyer that the financials are presented fairly and are in accordance with Generally Accepted Accounting Principles (GAAP). Utilizing reliable accounting systems and generating accurate accounting data eases the burden on auditors of gathering evidence to support their audit opinion and can alleviate the cost in obtaining one. Financial statements with robust accounting processes are often perceived as more reliable and can accelerate the sale process. Your accounting firm or CFO are important players in helping with the historic and projected financial statements. Some business owners utilize outsourced CFO services to help in this regard. The outsourced CFO services can help clean up financials, help install better controls, risk management and help develop budgeting.

The accounting of business transactions must generally follow industry standards and GAAP. GAAP requires most businesses to post accounting activity using the cash or the accrual basis of accounting. Potential buyers expect financial statements to be produced using the accrual method since it presents a more accurate picture of a company’s profitability and makes it easier to compare similar companies. The accrual basis requires a company to match revenue earned with the expenses incurred to generate the revenue. For instance, a bill is recognized as an expense in the month it is received, even if payment of said bill is delayed; whereas the cash basis, used by many small companies, recognizes income and expenses only when money changes hands.

• Cash accounting may sometimes distort profitability. A company using cash-based accounting may appear profitable until company expenses are paid. Business owners should consider using a CPA to confirm a company’s financial records comply with accounting standards and tax laws. Having prepared accurate financial statements increases the reliability of a company’s profitability and can raise the price received for it.
  
  
• A compilation is a financial report put together by a CPA firm that follows guidelines established by the American Institute of Certified Public Accountants (AICPA) to assure the financial statements are presented in accordance with GAAP or other recognized standards acknowledged by the AICPA. This is a relatively inexpensive report, compared to the other two reporting options, but it also provides no assurance.
  
  
• A review is the next step up and provides limited assurance. This report must also be done by a qualified CPA firm, but unlike a compilation, the firm must be independent; in other words, the firm has no financial interests in the business or with the area of the business it reviews. A review is typically two or three times more expensive than a compilation, with a corresponding increase in the level of work that goes into the review process, as well as the increased risk that the accounting firm assesses in preparing the reports. Reviews, however, are like compilations, in that they are the representation of management and not the CPA firm.
  
  
• An audit is typically a much more involved process and provides reasonable assurance that the financials are presented fairly, in all material respects and are in accordance with the stated financial framework, such as U.S. GAAP or International Financial Reporting Standards (IFRS). Audit procedures include an examination, substantive analytics, confirmations and, for some companies, the testing of internal controls. Audits can be two or three times the cost of a review and can even get into six figures, depending on the company, its size and the complexity of the transaction involved.

Sometimes a buyer may want a quality of earnings report as part of their due diligence process. Although a quality of earnings report is not an audit, it can help provide additional support for a target company’s revenue and expenses, including sustainability and accuracy of past operations. Some businesses may not be generating monthly internal financial statements or wait until year-end to book certain closing entries that should be made monthly or quarterly. In turn, any interim financial statements may be starkly different than what would be included in audited annual financial statements.

Although it is commonly recognized as a preferred metric, earnings before interest, taxes, depreciation and amortization (EBITDA) are important metrics in getting a business sold. However, there can be limitations in how EBITDA fails to address the need for growth reinvestment as a capital-intensive business doesn’t cash-flow as well as others.

For closely held businesses, there will always be adjustments regarding the seller’s activity. Sellers and other key members of management may be taking above-market compensation (called “excess” compensation) out of the business, which requires certain adjustments or replacements after the transaction closes. There could also be other discretionary bonuses and “unrelated expenses” the owner may be flowing through the business. With that knowledge to consider, it is important for the buyer to thoroughly examine and substantiate these amounts.

Strengthening a Company’s Value

A business owner’s main goal in getting a business sale ready is to increase a company’s marketability and value. In the event of a sale, company value directly correlates with the price received for the business. Increased brand awareness creates a larger customer base that can drive greater revenue and profits. Gross profit and operating margins can also be maximized by reducing the cost of a good or service. Costs may be reduced by forcing key suppliers to compete for your business.

Metrics should be used to monitor a company’s performance and identify areas of improvement. These metrics can strengthen a company’s value by offering insight into potentially necessary changes. Proactively increasing the value of your company by generating more revenue and profits often justifies a higher sale price when the time comes.

Gather All Company Documents

In preparation for exit, business owners must gather all company-related documents. These documents may include corporate bylaws, licenses, permits, tax returns, benefit plans, employment agreements, leases and contracts. Having these documents organized and readily available offers transparency that builds trust and confidence in the transaction.

Name and Train Successors

All this preparation, while time-consuming and often overwhelming, helps an owner maximize company value. Proper planning prevents owners from accepting low-ball offers and ensures he or she gets what is deserved for the company. However, this value is often threatened by owners having no succession plan. Owners may not have had the time to name and train the next generation and these leadership gaps are often detrimental to a company’s value.

Private equity or strategic buyers expect the next generation of leadership to be established and trained before the sale. If not, they may demand significant earnouts, claw backs or other draconian purchase covenants resulting in less money for the seller.

ESOP Considerations – Traditional 1042 ESOP & Roth ESOP

Owners with no prior succession plan, owners who would like to reward employees with an ownership stake in the business or owners who are not yet ready to relinquish complete control may consider selling his or her company to an Employee Stock Ownership Plan (ESOP). The implementation of an ESOP can be utilized as either a complete exit or an interim step for a third-party sale down the road especially if a successor management team or the next generation of family members are not up to the task, while creating wealth and aligning all stakeholders (employees, management, selling shareholders and society). A sale to an ESOP will require many of the steps necessary in selling to a third party.

Given the current economic environment, some banks may be cutting back their lending in sale transactions except to their existing clients. In the instance where banks are lending, current loan funding amounts may be lower compared to a few years ago when interest rates were lower. Additionally, the banks are typically asking for more financial covenants which are designed to lower their risk. This could potentially make ESOPs more attractive in the current environment. 

An ESOP enables business owners to gradually transition ownership to the next generation of ownership, be it family and/or the existing management team and reduces the risk of valuing abrupt changes often associated with third-party sales. Selling to an ESOP allows owners to transition leadership in a controlled and deliberate manner while maintaining continuity within the existing management team. Owners can receive liquidity from the sale of their shares, continue earning income if they remain employed and structure a tax‑efficient retirement strategy under the rules governing qualified plans. Employees participate in a regulated retirement plan that provides them with beneficial ownership in the company, subject to ERISA oversight and annual independent valuation.

An ESOP is a well‑established succession structure that aligns the interests of owners, employees and other stakeholders while supporting long‑term organizational stability.

Under current law, a 100% ESOP owned S Corporation will not incur any federal taxes. Most taxes follow the federal statute and do not tax ESOP S Corporation earnings. These tax benefits allow for potentially more tax-efficient monetization of the business purchase by an ESOP compared to a third-party sale.

A traditional 1042 ESOP exchange transaction enables selling owners to indefinitely defer capital gains tax on the sale of closely held C Corporations. At least 30% of the company’s equity must be sold to the ESOP, the stock sold to the ESOP must be common stock and the seller must have held the stock for at least three years before selling to the ESOP. Proceeds of the sale must be reinvested in securities or bonds of domestic operating companies within a 15-month period that starts three months before closing and ends 12 months post-close. Under this transaction, the business owner and family members cannot participate in the ESOP.

This strategy may make sense for an older business owner, with no family members in the business, who lives in a high tax state. While a Section 1042 transaction may be attractive to an older or ill owner, other ESOP designs such as the Roth ESOP could be more attractive from an economic perspective.

Business owners and family members interested in participating in the ESOP may do so by implementing a Roth ESOP. While this approach has been commonly used by public companies for many years, it is becoming increasingly prevalent in the private sector especially since Congress changed the law in 2022 to make it easier to do a Roth ESOP. This was allowed by Section 402A of the Internal Revenue Code.

Under the Roth approach, the invested ESOP equity is taxable today, but the retirement benefit (and its income) that is paid out after the later of five years and age 59.5 is withdrawn tax-free. This combined approach may result in superior economic benefits, increased investment flexibility and better alignment among stakeholders compared to the 1042 traditional ESOP transactions. 

Roth accounts might make sense for a worker if they are in a higher tax bracket at retirement or have a leveraged investment in the Roth account. ESOPs are always leveraged investments. For illustration purposes, consider a simplified scenario: an employee receives one share valued at $100 today and that share increases to $3,000 by the time they retire. Under a Roth ESOP structure, qualified distributions may be tax‑free, meaning the employee would not owe tax on the appreciated value if they meet all applicable requirements.

Under a traditional ESOP structure, the employee would generally owe tax on the distribution at retirement. However, this comparison depends on several factors, including future tax rates, diversification timing, valuation changes, participant eligibility as well as the company’s ability to manage repurchase obligations.

While Roth treatment can provide meaningful advantages in certain circumstances, employees and plan sponsors should evaluate these considerations carefully before determining which structure is most appropriate.

In a Roth ESOP structure and subject to applicable qualified plan, nondiscrimination and allocation rules, there may be opportunities (depending on workforce demographics) to allocate ownership in ways that more closely reflect the contributions of key employee groups. These “critical workforce segments” are those roles or teams that drive a disproportionate share of the company’s value creation relative to their peers. Determining criticality typically involves evaluating three core factors:

• What segments of the organization have the greatest impact on the value chain?
• Which segments of the organization possess the hardest skills to replace?
• What segments of the organization are currently in the shortest supply?

Examples of critical workforce segments may include management teams, engineers, scientists, chemists and other specialized roles whose expertise materially contributes to the company’s value creation. In today’s environment — particularly as artificial intelligence expands the supply of entry‑ and mid‑level talent — high‑skill and strategically important roles can be more challenging to attract and retain.

A Roth ESOP structure (which is subject to applicable qualified plan, nondiscrimination and allocation rules) may provide meaningful long‑term benefits for employees because qualified distributions can be tax‑free when all requirements are met. When aligned with the company’s demographics and financial profile, this structure can support retention and reward key contributors; however, these potential advantages must be evaluated alongside tax considerations, diversification timing, valuation risk, repurchase obligations and participant eligibility.

Ongoing Succession Planning

Preparing a business for sale is a comprehensive process that involves strategic planning, financial analysis, operational refinement and adherence to legal and regulatory requirements. Succession planning is a critical, ongoing component of this work and contributes directly to the long‑term stability and sustainability of the organization. Business owners benefit from developing a succession strategy well before they intend to sell, as it strengthens leadership continuity and enhances overall readiness.

An ESOP can serve as both a succession strategy and an exit pathway for current owners. Owners who want to position their business for a future sale or who are not yet ready to fully step away but are interested in increasing liquidity, diversifying personal assets or providing employees with a meaningful retirement benefit, may find an ESOP worth evaluating. If you think an ESOP aligns with your goals, we encourage you to contact us.

Contact Us

If you have any questions about ESOPs, please contact your PKF O’Connor Davies client service team or:

John N. Vitucci, CPA
Partner
jvitucci@pkfod.com | 917.841.8718

Himanshu Chaudhry, CFA
Managing Director, ESOPs
hchaudhry@pkfod.com | 404.825.0985