Understanding ESOPs: The Ownership Structure Enabling Stability, Retention, and Exits

By Marty McCarthy of CBIZ

Private equity (PE) has recently emerged as a major force driving business transactions in the construction industry and is partially responsible for the red-hot dealmaking activity we’re seeing today. In 2025, PE accounted for 55% of the M&A transactions in construction. The potential advantages of PE are generally perceived to be that it provides the most immediate cash windfall to owners and pave the way for large, consolidated entities to dominate markets and expand the reach of newly combined firms. However, there are drawbacks of such transactions. These include leveraged debt that impacts the returns expected on the acquired company’s cash flow, potential integration obstacles, and the reduction of headcount. Couple those potential pitfalls with the possible selloff of key productive assets along with the elimination of divisions, and you can see the issues that have made many selling shareholders look for alternatives to PE transactions in the construction industry.

Construction business owners seeking to avoid the common pitfalls associated with selling to PE may find a favorable exit and monetization alternative in Employee Stock Ownership Plans (ESOPs). ESOPs are structured sales in which a trust is created to purchase the shares of its sponsor company. The employees will be the beneficiaries of this trust and will eventually receive an allocation of company shares that will be distributed to them upon separation from the company. In effect, the longer an employee stays with the company, the more shares will be allocated to their account. The initial purchase of shares from the selling shareholders will be financed by (i) corporate cash, (ii) bank financing, or (iii) seller notes—all financed by either the company or the selling shareholders.

The unique benefits of ESOPs, including rewarding internal talent, preserving (to the extent necessary) the influence of leadership, and unparalleled tax advantages, can be particularly appealing in an industry like construction. In part, that’s because construction firms are often closely owned and take pride in their long-term relationships with employees, vendors, and clients. ESOPs are understandably compelling in an industry that values experience, knowledge, and skills that may be misunderstood or underappreciated by outsiders. In this article, we’ll discuss several reasons why construction business owners and their bonding partners may find ESOPs to be the ideal structure for preserving a business’s key assets while enabling stakeholders to exit.

Because an ESOP transaction is a leveraged buyout, it is essential to understand how traditional debt and ESOP-related debt are treated differently.

The Debt Difference

Debt in an ESOP transaction can be more flexible and favorable to the business than traditional debt structures implemented in other deal structures. Here’s why:

Under certain fact patterns (particularly if the company is a Subchapter S corporation, post-transaction), the proportion of the company’s taxable income owned by the ESOP (from a minority interest up to 100% of shares owned by the ESOP Trust), is nontaxable. In addition, when an ESOP-owned company is exposed to taxes (whether a C or an S corporation), principal and interest payments related to an inside ESOP loan are tax-deductible.
ESOP transactions can involve issuing seller’s notes (subordinated notes in lieu of cash) to selling shareholders, delaying a portion of the payout. As a result, banks and sureties classify this debt as “friendly debt,” with equity-like features and benefits to the business’s debt capacity. Further, the selling shareholders will earn the interest income, as opposed to the bank receiving interest income on this debt in the capital stack, while also providing warrants to the holders of this debt, with such warrants acting as options, providing significant upside potential in any cash-out upon exercise, available down the road.
Likely as a result of the features above, ESOPs are associated with a significantly lower risk of default (approximately 1.3% versus 3.75%), according to a 2014 study carried out by the National Center for Employee Ownership (https://bit.ly/4cd5qT4), which analyzed default rates during the acute period of financial distress from 2009 to 2013.

Collaborative Considerations

Construction firms rely on crafting capabilities, skilled workforces, and hard-earned know-how as well as the trust and resources of the financiers they partner with. For an ESOP to succeed, the company needs to retain the confidence of its financial partners and vendors. Here’s how companies pursuing an ESOP can preserve their relationships with key providers, such as their surety companies.

Leveraged monetization structures, such as an ESOP transaction, are viable only if working capital remains strong post-transaction. Covenants focused on working capital should be carefully reviewed in the context of additional ESOP-related senior/secured debt. Feasibility cash-flow analyses are integral in making sense of new debt levels, while post-transaction cash flows must consider the ESOP-related tax advantages to assist sureties and banks in making practical sense of their impact.
Being proactive in the ESOP transaction process keeps sureties engaged and informed. Educating all parties, particularly concerning the beneficial aspects of tax savings, can ensure that everyone is on the same page and knows what to expect post-close.
Construction company transactions that are structured with responsible purchase prices and feasible and sensible levels of leverage (particularly considering the positive tax impact on a post-transaction basis), combined with optimal post-transaction working capital levels, are best positioned to undergo a sale to an ESOP. Meanwhile, highlighting the ongoing availability of key management personnel and a well-trained/retained workforce is an unquantifiable advantage (especially in the eyes of sureties) that can benefit the business as it adapts to the new form of ownership in place.

The Value of Stability

Anyone involved in the construction industry can appreciate the value of firsthand experience. That’s as true of skilled trades workers as it is of bond issuers. The unique nature of construction projects puts a premium on the confidence and competency that comes with experience. It’s also why ESOPs can be uniquely advantageous.

ESOPs support retention and continuity goals by incentivizing employees to remain with the company on a long-term basis. The longstanding labor crunch in construction has recently alleviated alongside diminishing demand in residential and commercial sectors, but markets change quickly. The scarcity of talent will likely reemerge as an acute pain point as soon as demand rebounds. ESOPs make retention as rewarding for construction firm employees as employers, reducing the likelihood that rising pay rates will turn the heads of valuable employees in the future. Hiring initiatives can also benefit from stock appreciation rights (SARs), deferred compensation plans that arise in most ESOP transactions and that are available only to key executives driving company value, post-transaction. The promise of receiving fully vested shares (equating to a cash payout that rises as the company’s value rises), if staying with a company post-transaction, is a compelling and rare benefit that relatively few in the industry are able to offer.

Evaluating ESOPs

Ultimately, any sale or ownership transition can introduce risk. Equally, kicking the can down the road and not addressing ownership succession planning carries its own risk. Accurately gauging that risk requires paying attention to the right indicators, and the metrics that are most influential in a sale to PE are not necessarily the same as those that apply in an ESOP.

To properly gauge the suitability of an ESOP, sureties need to understand their debt and tax implications, along with the benefits that will inure to the company, as well as its key executives and overall employee base. Sureties should also calculate the anticipated working capital needs of the business, post-close, to determine that the transaction will not impact the company’s bonding needs. Communicating the result of that calculation, during the planning phase of the transaction, can help ensure there are no surprises post-close.

Also consider the flexibility possible through the use of seller’s notes, if included in the deal, and intangibles, like the ESOP’s effect on the commitment and morale of employees and the possible ongoing involvement of key figures post-close. For example, sureties involved in an ESOP might ask, “If the labor crunch reemerges, what is the business value of the company being able to attract talent by offering all employees shares of its company’s stock (as a supplemental investment vehicle, often in addition to a company’s 401k plan)?” They might also ask, “How will the business’s financing capacity be affected, and how will that change depending on the capital structure mix of senior (secured) lending versus seller financing?”

Conclusion

In an industry that values institutional knowledge, continuity, and specialized experience, ESOPs are a particularly appealing option for owners seeking to exit or monetize without withdrawing entirely. In the days after a major capital transaction, all interested stakeholders should know the key factors impacting a company. From the perspective of a surety that bonds a valued construction company, the ideal answer may be that the business remains largely intact with entrenched stability and retention mechanisms—and that’s exactly the result that ESOPs can make possible.

Marty McCarthy, CPA, CCIFP, is a Managing Director in the Tax Practice at CBIZ and serves as the Mid-Atlantic Construction Leader. With more than three decades of experience serving construction companies, his collaborative, solutions-focused approach, combined with deep technical expertise and industry insight, has made him a trusted advisor to clients across the industry. McCarthy serves on the NASBP CPA Advisory Council. He can be reached at [email protected].