How an ESOP allows a physician to sell their practice and keep it independent

As a medical practice owner, succession planning can sometimes feel like an afterthought. It’s not uncommon to be more focused on the day-to-day operations of your business. But succession planning can take time, and waiting too long can lead practice owners to make a decision without having developed a nuanced understanding of their options.

At Meroka, we believe in the power of independent medical practices, and we’re helping existing practices stay independent without compromising on their ethics or monetary value. We do this through Employee Share Ownership Plans, or ESOPs, an overlooked hidden gem that’s the perfect transition tool for closely held, independent businesses with deep community roots (like medical practices).

But what is an ESOP, what type of business is it good for, and how does it all work? Read on for an overview.

What is an ESOP?

An Employee Share Ownership Plan (ESOP) is a workplace benefit that grants employees shares of the business. ESOPs are a form of qualified retirement plan, like a cousin to a 401(k), with several distinctions:

• While a 401(k) is an investment in a mutual fund, an ESOP is a direct investment in the company you work for.
• ESOPs are company-funded, not employee-contributed like a 401(k). This means that employees don’t need to invest anything to start building wealth.
• ESOPs typically have a vesting period, much like traditional stock option plans. This means employees build ownership by working, not by paying into it. An ESOP also rewards excellence, because the better an organization performs, the greater its value becomes.
• When an employee leaves the business or retires, they cannot continue holding ownership of those shares. Instead, the company buys back their vested shares and they receive a cash payment.

ESOPs originated in the 1950s and grew in popularity during the ‘90s, yet remain relatively unknown. As of 2020, there were fewer than 6,500 ESOP plans in operation. Publix supermarkets and W.L. Gore and Associates, the maker of GoreTex, are examples of larger, more established ESOP businesses.

With an ESOP, employees’ future financial security is tied to the success of the business. ESOPs have stronger employee retention than their counterparts and employees report greater job satisfaction, largely because they have more skin in the game.

Under an ESOP, all parties benefit: a medical practice retains its independence, employees benefit from company success, and the practice owner can generate wealth from their life’s work. Put simply, an ESOP is both a liquidity plan for the physician-owner and a succession plan that doesn’t require compromising.

What are the advantages of an ESOP?

ESOPs are unique in that they benefit both the owner-seller and employee-owners in several ways, both financially and culturally:

ESOPs are more resilient

A report by Rutgers University found that ESOPs have significantly higher employee retention rates than other businesses and are less likely to cut pay during times of crisis, such as the early days of the COVID-19 pandemic. The research suggests that employee ownership contributed to greater job stability than emergency government spending. The National Center for Employee Ownership (NCEO) estimates that employees who are part of an ESOP company have double the retirement savings of traditional companies.

ESOPs carry tax benefits

Government regulators and the Department of Labor have given ESOPs special benefits, such as a tax shield, to allow employees to more directly benefit from their work. Through this lens, an ESOP functions as a for-profit company operating on a tax-free basis. The tax savings alone can be enough to fund the operations of an ESOP!

Sellers can earn more 

When an ESOP is established, the owner is not taxed on capital gains. Because of this, they’re able to earn 30–50% above market rate. That means that a business owner can receive up to 150% of the fair market value for their company!

How do you know if an ESOP is right for your business?

An ESOP isn’t right for every business, and many businesses won’t work as an ESOP for a number of reasons.

It has a culture of trust

First and foremost, a company that can’t survive without its owner is not a good candidate for an ESOP because an ESOP functions as a succession plan for the business. 

It’s invested in the local community

The majority of ESOPs are professional services companies, such as advertising or PR firms. ESOPs are typically “businesses that care,” as Finnell explains. They likely have deep ties to their community and don’t want to outsource labor, abandon the people who helped them along the way, or compromise on high-quality, high-touch client services. As pillars of their local community that have worked hard to build trust, independent medical practices are great candidates for ESOPs.

It’s stable and profitable

To be a strong ESOP candidate, a business needs to have a steady and diversified revenue stream. Setting up an ESOP can cost over $40,000. Businesses typically borrow money to fund the ESOP, and that loan ultimately needs to be repaid.

Additionally, because the cost to purchase shares can be significant, a business that sees frequent turnover or can anticipate a significant number of tenured employees leaving at or around the same time may not be a good candidate for an ESOP. In an interview with Medical Economics, Michael Bannon, Vice President at CSG Partners, encouraged that a practice should have “a younger generation of physicians that are coming in to see patients and physicians that are leaving the practice as they retire.”

ESOPs in the medical field

As of 2024, healthcare businesses made up just 2% of ESOPs, most of which are concentrated in the Midwest, along the East Coast, and in California. With the future of independent practices threatened by consolidation from private equity firms and health systems, ESOPs can be a win-win-win for physician-owners.

Bannon explained that ESOPs can preserve the “legacy medical practice that's been built up throughout their careers” while also unlocking tax benefits that can allow practices to reinvest in the practice’s resources and growth. ESOPs can be powerful recruiting tools, as they grant physicians the many benefits of an independent practice with the financial upside of ownership.

Because some state laws limit ownership of medical practices to physicians, a practice may need to organize a management services organization (MSO) before selling to an ESOP. In doing so, the MSO becomes the hub of business activities, while the practice is focused solely on providing medical care, and the ESOP would be formed under the MSO. 

It’s important to note that this would not have an impact on the day-to-day operations of the medical practice. Under an ESOP, doctors retain clinical autonomy and would not be told how to run their business.

How is an ESOP set up?

Setting up an ESOP can be costly and time-consuming. It also isn’t always easy to find lenders and advisors who are well-versed in the mechanisms of ESOPs. That’s where Meroka comes in. We take care of the tedious work of establishing an ESOP to support physician-owners with succession planning and ensure that their medical practice remains independent.

Here’s what our team does behind the scenes:

1. Creation: We establish a trust to buy the company’s stock, partner with you to organize a board, and appoint an ESOP trustee, an objective third-party who sits on the company’s board and makes decisions with employees’ best interests in mind.
2. Funding: We fund the trust through loans and feed the ESOP with tax-deductible annual contributions of company shares or cash for the ESOP to buy company shares.
3. Compliance: We manage the nitty-gritty, behind-the-scenes elements of an ESOP, like conducting annual appraisals, allocating shares to individual accounts, purchasing employee shares when they leave the company, and more.

In summary

Independent practice owners have a lot to gain by selling their business to an ESOP, but the hurdles required to establish one can be a deterrent. At Meroka, we’re invested in the future of independent medical practices and believe that ESOPs can be a means of pushing back against consolidation and acquisitions. ESOPs not only support business owners, but also physicians, their patients, and local communities.