Everything Construction Company Owners Need to Know About ESOPs

Transitioning the ownership of your business is one of the most significant decisions you will ever make. Whether you’re looking toward retirement, seeking a tax-efficient exit strategy or focused on preserving the legacy of the company you’ve built, selecting the right transition plan is crucial.

Selling to a third party or passing the business to a family member are common options. But another path helps owners realize their financial goals, maintain their company’s legacy and benefit their employees: an employee stock ownership plan (ESOP).

An ESOP allows employees to become owners of the business. While the concept might seem straightforward, the reality involves numerous complex considerations that deserve careful analysis.

In this introductory guide to ESOPs for construction company owners, we’ll take an in-depth look at ESOPs, how they work and why they’re becoming increasingly popular among construction businesses. We’ll explore factors owners should consider before choosing this path and share the challenges construction businesses face in transitioning to employee ownership.

At James Moore, our construction CPAs have advised several construction companies that have implemented ESOP structures. We provide accounting, assurance and tax support to a wide range of construction businesses, helping business owners lay the foundation for solid growth. 

Understanding ESOP Structures

An ESOP is a form of employee benefit plan that gives workers ownership interest in the company through stock. Rather than selling a construction business to an outside buyer, an owner can transfer shares to an ESOP trust that holds and allocates shares to employees. Employees’ stock vests over time, rewarding individuals who spend multiple years with the company with an ownership interest.

ESOPs can be structured in different ways, but there are two primary models:

• Leveraged ESOP: This is the most common structure. The ESOP takes out a loan to purchase the owner’s shares, and the loan is repaid over time using company profits.
• Non-Leveraged ESOP: Instead of taking out a loan, the owner gradually sells shares to the ESOP. Employees earn ownership over time.

Under both structures, the goal is to transfer ownership of the business in a way that provides financial liquidity to the exiting owner while creating a long-term incentive for employees to remain with the company and contribute to its success.

Some companies find that a hybrid approach that blends leveraged and non-leveraged structures offers the best of both worlds. By combining elements of both, owners can receive some immediate liquidity while maintaining ongoing involvement in the company. This flexibility in structuring the deal can help address concerns about both immediate financial needs and long-term company stability.

Are ESOPs a Good Fit for Construction Companies?

The nature of the construction industry makes ESOPs particularly attractive as a succession planning tool. Perhaps most significantly, the persistent challenge of employee retention can be transformed through the power of ownership.

Unlike traditional benefits packages, an ESOP creates a genuine ownership mentality among employees, since they must typically remain with the company for several years to become fully vested in the program. This vesting period naturally encourages longer-term commitment; employees recognize that leaving for marginally higher wages elsewhere means forfeiting their ownership stake. Even after an employee is fully vested, they’re less likely to leave since they own a portion of the business.

When a company transitions to ESOP ownership, it can become exempt from federal taxes depending on how it is structured. For this to be the case, the company must be structured as an S corporation that is fully owned by the ESOP. C corporations can benefit too, receiving significant deductions for their contributions to the ESOP.

This transformation eliminates the common year-end scramble to make tax-motivated purchases of equipment or other assets. Instead, management can focus purely on business-driven decisions that enhance long-term value. The tax benefits extend to employees as well, who (as with a 401(k) plan) don’t have any tax obligations on their ownership stakes until retirement.

Perhaps most compelling for many owners is the ability to preserve their company’s legacy. Unlike a sale to private equity firms (which often implement dramatic changes to maximize short-term returns), an ESOP allows the company’s culture and values to endure. This continuity proves especially meaningful for owners who have invested decades building not just a business, but a pillar of their community.

As the owner of the business, you can also experience some tax benefits in selling your business to an ESOP vs. to a strategic or financial acquirer. The IRS permits taxpayers to defer capital gains taxes when selling at least 30% of a C corporation to an ESOP, provided the taxpayer reinvests in Qualified Replacement Property (such as stocks and bonds of U.S. companies). Plus, if you opt for a non-leveraged or hybrid ESOP structure, there’s the opportunity to spread income from the sale of the business across multiple years — minimizing your overall tax rate.

Is an ESOP Feasible for Your Construction Company?

We’ve established that ESOPs can suit many construction businesses. But is it a good fit for your construction business? Every company is different, and for an ESOP to be a suitable choice, your company should have several characteristics.

Financial stability is the cornerstone of any successful ESOP implementation. Your company shouldn’t just be profitable; it should have a track record of producing consistent cash flows capable of supporting loan payments. Most successful ESOP transitions occur in companies with predictable earnings patterns. For instance, a construction company consistently generating annual profits of around $1 million might structure loan payments around $600,000 – $700,000 annually, providing a cushion for inevitable business cycles. Make sure your construction accounting is robust and that financial stakeholders will have confidence in your financial statements.

ESOPs only really make sense for established businesses with EBITDA of $1 million or more. For smaller businesses, the costs of establishing an ESOP might be prohibitive and outweigh the potential benefits. The key lies in having sufficient scale to absorb the administrative costs and complexity of ESOP ownership while maintaining operational efficiency. It’s not all about the size of the business; companies also need a mature management structure capable of collaborative governance.

Finally, consider the culture of the company you’ve built. Companies with strong team-oriented cultures typically find the transition to employee ownership more natural than those with more hierarchical structures. The shift requires not just financial restructuring, but a fundamental evolution in how employees view their roles and responsibilities within the organization.

The ESOP Process: Steps to Transition

Transitioning to an ESOP is not a simple process, but careful planning and experienced professional guidance help ensure a smooth ownership transfer. Here are the key steps involved:

1. Feasibility Study

Conducting a feasibility study is a prerequisite before committing to an ESOP. This external evaluation provides an objective assessment of whether an ESOP is a viable option based on the financial performance, cash flow and structure of your business.

2. Business Valuation

An ESOP acquires your company at the fair market value of the business. To determine that value, you’ll need to obtain a formal business valuation. An independent appraiser will assess company performance, industry trends and financial statements to establish a price for the ESOP transaction.

This valuation is critical, with the resulting figure impacting everything from purchase price to ongoing share value calculations. The independence of this valuation proves crucial for maintaining the ESOP’s integrity and ensuring fair treatment of all parties.

3. Structuring the ESOP

Together, owners and employees must decide on the right ESOP structure. Consider factors such as:

• Whether to use a leveraged or non-leveraged structure
• Choosing between an S corporation ESOP (which offers tax advantages) or a C corporation ESOP (which provides additional flexibility)
• Determining the percentage of ownership to transition initially versus over time

Company owners must work closely with their employees here. Appoint an ESOP trustee — an individual or entity tasked with representing the employee shareholders’ fiduciary interests. This trustee can either be an internal team member (such as your current COO or CFO) or an independent third party. Work together to find a sustainable structure that works for every stakeholder: the business owner, the new employee ownership group and the financing partners supporting the transaction.

Determining ownership allocation presents another nuanced challenge. Companies must develop equitable formulas that consider multiple factors including tenure, compensation and performance to divide equity among employees. These formulas need to be both fair and motivating while remaining simple enough for all employees to understand their path to increased ownership.

The ESOP must be legally established with a formal plan document, trust agreement and governance policies. Legal professionals draft the necessary agreements and the ESOP trustee represents the interests of employees.

4. Ongoing Management and Compliance

Once an ESOP is in place, the company must conduct annual valuations, file required reports and ensure compliance with Department of Labor and IRS regulations.

Companies often work with CPAs, auditors and valuation experts to maintain the financial and legal integrity of the ESOP plan. It’s important to consider the additional costs associated with this before establishing the ESOP, since compliance activities like annual audits typically increase in complexity and cost. Regular valuations become necessary, and the company must maintain sufficient cash flow to service any acquisition debt while funding ongoing operations and growth initiatives.

Moving Forward: Start Preparing for Your Transition With James Moore

Construction company owners contemplating an ESOP should begin by engaging in detailed discussions with financial advisors who understand both ESOPs and the unique dynamics of the construction industry. These conversations should explore not just the mechanical aspects of forming the ESOP, but also the broader implications for company culture, operational efficiency and long-term sustainability.

The success of an ESOP transition ultimately depends on careful preparation, strong financial fundamentals and a genuine commitment to fostering a culture of ownership. While the process requires a significant investment of time and resources, the potential benefits for all parties can make ESOPs an attractive transition planning tool for construction company owners ready to begin their next chapter.

James Moore has experience assisting construction companies through the ESOP process. Our team provides ongoing accounting and compliance support throughout the ESOP process, helping construction businesses transition to an employee-owned model while maintaining operational stability.

If you’re exploring ESOPs for your construction company, James Moore can help guide you through the process. Whether you need help with understanding the tax ramifications or need an introduction to specialized ESOP professionals, our advisors are here to help. Contact us today to learn more about how we can support your company through the transition planning process.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.