For many companies, employee ownership offers a compelling, win–win proposition. Done well, it aligns and rewards the workforce to support stronger operating performance and, in many cases, provides a path for long-term ownership transition. As a result, employee ownership can offer a business transition solution that preserves the culture and legacy an entrepreneur has built.
Yet businesses considering employee ownership consistently raise the same question: how can employees afford to purchase a meaningful stake in a private company?
The answer varies based on the structure of the employee ownership plan, details of which can be found in a recent BMO article. But for any employee ownership plan intended to serve as an ownership transition strategy, such as an Employee Stock Ownership Plan (ESOP) in the U.S. or an Employee Ownership Trust (EOT) in Canada, financing is often the solution. A thoughtful approach to financing an employee ownership transaction can:
Enhance liquidity for selling shareholders
Accelerate the transition to employee ownership
Promote accessibility for all employees
This article will cover the range of financing solutions available, as well as how businesses can prepare to optimize their overall capital structure in an employee ownership transaction.
Five Financing Solutions
As with any traditionally owned business, five categories of financing are available to support an employee ownership transaction. Four are external sources of capital that unlock liquidity for sellers, including senior term loans, or debt, equity, and personal loans (for employees). The fifth is vendor (or seller) financing, which bridges any gaps.
1. Senior term loans: structure and affordability
Senior term loans typically provide the largest and most affordable portion of an employee ownership capital stack. They sit at the top of the capital structure, come with clear repayment schedules and covenants, they’re often the cheapest form of capital compared to other options, and they reward predictability. Bank underwriting focuses on maintainable free cash flow—not just net income—because free cash flow is what's available to repay debt. Typically, a lender will review multiple years of historical financial performance as well as forecasts to size the facility appropriately. Senior debt capacity is calculated based upon a company’s cash flow available to repay debt—during upswings and downturns—as well as its collateral. This commonly ranges from 2.0x to 3.5x maintainable EBITDA, with amortization commonly set over five to 10 years. Pricing is often framed as a spread over the prime lending rate or SOFR (Secured Overnight Financing Rate), depending on the region. The terms of senior debt financing vary significantly based on the borrower and overall market conditions. The trade-off for the lower cost of senior term loans is structure: scheduled principal and interest payments take priority over new investments or distributions, and covenant packages manage risk. There are also reporting requirements, including financial statements, covenant compliance certificates, field exams, etc. While meaningful, this incremental reporting can provide leadership with useful discipline related to annual and longer-term financial planning.
2. Junior debt: enhanced liquidity
Junior debt is financing that ranks behind senior lenders and ahead of equity. Also known as subordinated debt, it includes second lien and mezzanine debt structures. In an employee ownership transaction, junior debt can increase upfront liquidity for selling shareholders when senior lenders have reached their comfort limit, while preserving maximum ownership for employees. Junior debt is typically “patient” and allows for greater liquidity preservation as there are no or limited annual principal payments, with repayment occurring at one time in a bullet at maturity. Junior debt always matures after senior debt, allowing time for operators to execute growth plans.
Structures for junior debt are tailored but often involve interest that can be capitalized, or paid in kind (PIK), or can include warrants1 to balance cost and upside. Pricing is generally fixed, with no scheduled principal repayments. The rate is adjusted for risk, structure, and borrower quality. While the flexibility comes at a higher cost than senior debt, it remains cheaper than issuing new equity and comes with lower to no dilution for the existing shareholders.
3. Equity: long-term flexibility
Though less common for employee ownership transactions, equity’s core benefit is flexibility, as it can provide a cushion against interest-rate volatility and covenant pressure. Terms are often structured to protect downside for investors, such as preferred share classes or minimum return hurdles before common equity participates.
For ESOPs in the U.S. and EOTs in Canada, there are important regulatory considerations associated with raising equity. Outside equity can have an impact on ESOP-owned companies’ corporate tax status. Nonetheless, there are innovative structures, such as the drop-down LLC2, which can help mitigate tax leakage for S corp ESOPs. For EOTs, it’s important to ensure that any equity (or equity-like features) does not run afoul with the requirement for the EOT to hold a controlling interest (over 50%).
Arguably what’s most important is to find the right type of equity investor that’s aligned with the employee ownership model in terms of value creation goals and timing considerations. For example, traditional private equity firms that seek control positions with five- to seven-year holds may not be aligned with models such as ESOPs or EOTs, as their shorter-term profitability goals may conflict with the company’s employee engagement and reinvestment priorities. In those situations, alternatives such as bank-affiliated funds, dedicated employee ownership funds, family offices, or government-backed investors may be a better fit.
4. Personal loans for employees: direct employee purchases
Another financing solution is personal loans to employees to purchase shares directly in a company. In an ESOP or EOT, this would be executed outside of the trust and would involve using personal loans approved on individual merits and assets. Other employee ownership plans can employ hybrid solutions that use the company’s balance sheet to back personal loans to employees. Any path that involves personal financing for employees demands careful education. Private company shares are illiquid, time horizons can be long, and personal leverage should match risk tolerance and tenure. For many companies, broad-based ownership is better achieved indirectly through trusts or company-level financing rather than widespread personal borrowing.
5. Vendor (seller) financing: the pivotal bridge
While there is a range of external financing solutions available, it’s common for employee ownership transactions to have a meaningful requirement for vendor financing. These seller notes often become the linchpin in employee ownership transactions. Vendor financing is highly flexible and can be the lowest—or highest—cost piece depending on the seller’s objectives. Features can mirror other financing instruments, combining amortization, interest deferral, or performance-based elements (such as warrants) to match liquidity needs without overleveraging the business. Seller financing would be subordinated to any forms of senior or junior capital and would have little to no rights and remedies in bankruptcy.
Why financing matters
Not every employee ownership transaction requires external financing. In ESOPs or EOTs, some owners choose to provide 100% seller financing, deferring liquidity while preserving company flexibility. The choice depends on objectives (legacy, timing, taxes) and the company’s capacity to sustain investment.
Used thoughtfully, however, financing can accelerate the transition to broad-based employee ownership in a way that keeps access equitable. It allows employees to benefit economically without upfront cash outlay and enables selling owners to achieve liquidity in stages aligned with the company’s health. For capital-intensive businesses or those pursuing strategic investments, setting initial leverage conservatively and planning a recapitalization two to three years after close—once amortization has deleveraged the company—can create additional liquidity without compromising resilience.
Success in raising capital for an employee ownership starts well before the transaction. It’s important to build relationships with capital providers early—ideally months or years in advance—and to be transparent about risks and assumptions. Borrowers should sensitize forecasts for interest rates, demand, and economic cycles to ensure that they have sufficient cash flow for debt service through cycles. When negotiating, prioritize covenants that protect reinvestment capacity. In cross-border situations, expect longer diligence cycles and tighter terms. Risk-sharing tools and advisory support (e.g., from export agencies) can help navigate uncertainty and expansion.
Employee ownership is more than a transaction—it’s a long-term operating choice. Financing is not always required. But when it is, the right mix of senior debt, junior capital, equity, and seller participation can deliver a transition that protects legacy, rewards employees, and preserves the company’s capacity to grow.
BMO Capital Partners (“BMOCP”) provides bespoke junior capital solutions to middle‑market and early‑stage companies across North America. As an evergreen, long‑term investor, BMOCP is not bound by fund‑cycle timelines and can support multi‑year growth strategies with flexibility. Integrated collaboration with BMO’s senior lending, treasury, corporate advisory, and capital markets teams enables coordinated underwriting and a streamlined documentation/closing process. With a long track record across industries, BMOCP consistently delivers tailored structures and reliable execution.
1 Warrants are an instrument that provide equity upside. Similar to stock options, warrants are a right to buy shares at a future date, but at the current price. This provides a warrant holder with participation in the growth of a company’s share value.
2 A drop‑down LLC is a new subsidiary entity—typically an LLC—formed beneath the existing ESOP‑owned operating company (or holding company). Selected assets, business lines, or future growth initiatives can be “dropped down” into this new entity. It can allow the ESOP company to retain control, but new investors buy equity at the subsidiary level. For more information please consult ESOP tax, legal and M&A professionals