🔒Starting an ESOP: Central Mass. businesses unpack the how and why of employee ownership

Westborough-based Landry’s Bicycles has operated in Central Massachusetts since 1922, but longtime owners and brothers Peter and Tom Henry faced a fork in the road in 2009 as they researched a succession plan. Like many business owners, the Henrys had two obvious options: sell to a competitor or liquidate. Neither seemed right for the community-focused bike shop chain, so they chose a different path: forming an employee stock ownership plan. ESOPs are tax-qualified retirement plans authorized under federal law and primarily invested in the stock of the sponsoring company. They directly tie employees’ retirement accounts to the success of the business, giving workers a vested interest in the company. “One of the things that they wanted out of their small business was to have staff that were able to buy a house and to grow the middle class,” said James Ray, Landry’s director of marketing and business development. “It was something really important to them.” ESOPs are not the right fit for every company. Companies need a solid financial foundation, an understanding of regulatory requirements, and — with some exceptions — a minimum fair market value of about $10 million.

For firms where ESOPs are a good fit, they create a work environment second to none, generating strong returns and greater employee buy-in, said John Biagioni, president and CEO of Uxbridge-based manufacturer Lampin Corp. “I believe the environment it sets up for the employee owners is better than any I've been in,” Biagioni said. “I wish I had known about ESOPs 20 years ago."

Unlocking liquidity for owners

Tony DaSilva, a partner at Worcester-based law firm Mirick, has helped many companies establish ESOPs during his nearly 40-year career. ESOPs provide longtime owners a unique opportunity to access wealth tied up in their businesses. Selling shares to an ESOP converts equity into cash while unlocking unique tax advantages, DaSilva said.

“If an ESOP owns over 30% of the company, then the sellers can roll over the gain on their shares into an alternative investment and not pay any tax,” he said. “They can avoid state income tax as well as the federal tax.” This is particularly impactful in Massachusetts, where the state’s millionaire tax adds a 4% rate to income above $1 million. ESOPs can improve a company’s bottom line, as profits attributable to stock held by the ESOP trust are exempt from federal income tax.

Healthier & happier

ESOPs aren’t just for owners seeking financial benefits. Delcie Bean is the founder of Paragus Strategic IT, which has offices in Worcester and Hadley. The company began forming an ESOP in 2013, became 40%-ESOP-owned in 2016, and reached 100% employee ownership in 2024. For Bean, the motivation was twofold. With employees having skin in the game and a seat at the table, he believed employee ownership was a practical path toward a stronger, healthier, and happier company. There was also a philosophical reason. “I fundamentally like the idea of shared equity,” Bean said. “It's not really fair all that hard work benefits one or two people in the company more than everybody else. If we're all going to work really hard together, then we should all benefit together. An ESOP is a good model for doing that."

Feasibility & funding

The first step toward an ESOP is a feasibility study. Financial advisers and attorneys determine whether a company is a good fit. Strong candidates generally have growing cash flow and a value of at least $10 million, DaSilva said. “That's really step one, and it’s a go-no-go process,” he said. “If the feasibility study shows you’re not a good candidate, you stop before you get too deep into it.” These studies ensure a company has enough cash to manage the ESOP transaction, debt service, and ongoing plan costs, Bean said. If the study is positive, the next step is a company valuation. Under federal law, an ESOP cannot pay more than fair market value for shares purchased from an owner. The valuation firm reports to the ESOP trustee, not the owner, and provides a range of acceptable values.

This creates what Bean called an unusual dynamic: The seller negotiates with a trustee they hired and pay, but the trustee has information the seller does not. “The valuation you get is likely going to be less than what private equity would pay for your company, so you're already going to take a bit of a haircut there,” Bean said. DaSilva said a specialized group of lenders – typically banks with private banking divisions – understands ESOP financing structures and regularly handles these transactions. Sometimes the selling shareholder also acts as a lender, taking back a note rather than requiring all cash at closing, making transactions more viable. The company can deduct both interest and principal on the ESOP loan. Unlike ordinary commercial debt, this tax treatment is unique to ESOP structures, DaSilva said. A leveraged ESOP uses borrowed funds to purchase shares upfront, allowing a large payout to selling owners. A non-leveraged ESOP has the company contribute stock or cash directly to the trust over time without debt.

Operating an ESOP

Employee stakeholders must decide how shares are allocated and vested, and companies need a strategy for repurchasing vested shares from departing employees. That obligation grows as share prices rise and employees leave, requiring careful planning from the start, Biagioni said. “Even though you might look cash rich initially, the fact is there will be a day of reckoning,” he said. “When the time comes, you have money available to you without any issue.” Companies must decide whether to use an internal or external trustee and establish rules governing employee voting rights, which are often limited to major corporate transactions. Sometimes those rules need adjustment. Both Landry’s and Lampin initially set ESOP eligibility at age 21 before realizing younger employees wanted to participate. Both later lowered the age to 18. “For me, the most pride in our ESOP is when somebody on our sales floor meets a customer, and the customer asks to speak to the owner, and you see this 20-year-old say, ‘Well, I'm an owner, I can help you,’” Ray said. “There's this level of ownership and trust inside of Landry’s because of it. We all have a real vested interest.” Eric Casey is the managing editor at Worcester Business Journal, who primarily covers the real estate and banking & finance industries.