Many successful business owners are, or soon will be, seeking a buyer for their business. Often the next generation does not want to continue the business and it is often difficult to find a suitable third-party buyer. An employee stock ownership plan (“ESOP”) is a possible solution. ESOPs can provide considerable flexibility in structuring the sale, permitting the business owner to sell a part, or all, of his or her stock in a tax-efficient manner. It may also allow the business owner to retain control of the business after the sale.
What is an ESOP?
An ESOP is a special kind of qualified retirement plan designed to give employees an ownership stake in their company by investing primarily in the stock of the company. Most ESOPs are leveraged, which means that the ESOP uses borrowed funds to purchase company stock.
Benefits of an ESOP.
Sale to an ESOP is the only strategy by which an entity can purchase stock of a selling shareholder using pre-tax dollars. In addition, if the company is a “C” corporation, a selling shareholder who sells to an ESOP may be able to defer (and in some cases, eliminate) income taxes on the sale of stock. If the company is an "S" corporation partially or completely owned by an ESOP, there is no tax on the ESOP's share of the company's earnings. These tax advantages and the increased flexibility of an ESOP can be a compelling alternative to other succession planning strategies.
In addition to providing significant tax benefits, the sale of stock by a shareholder to an ESOP may:
• provide additional liquidity for selling shareholders
• provide a market for the stock owned by minority shareholders
• provide a “tool” for transferring business to other family members
• provide financing sources and alternatives that might not otherwise be available
• enable selling shareholders to get top value for their stock
• enable selling shareholders to maintain control of the business following sale
• maximize after-tax proceeds for selling shareholders and provide them with unique estate planning and tax-saving opportunities
• provide significant tax savings to the company
• provide more favorable terms and conditions of sale than what can be obtained from a third party buyer
• allow easier negotiations, less due diligence and an earlier closing date as compared to sale to a third-party buyer
• reward employees for their loyalty and allow them to participate in the future growth of the company
Characteristics of a Good ESOP Candidate.
Good ESOP candidates are small or mid-sized companies that have solid operating performances, stable cash flows, and a quality senior management team. The importance of the management team cannot be over emphasized, as they are the ones who will run the company once the shareholder leaves. To be cost effective, the business should have a value greater than $3 million. Partnerships and LLCs are not eligible to sponsor ESOPs but there are ways to structure the transaction so that they can benefit from an ESOP.
ESOPs are a Hot Topic
The media has numerous stories of successful ESOP companies. ESOPs can be utilized by a company in almost any industry and the tax savings are often significant. If you are a business owner who is considering the sale of your company, an ESOP may be a valuable, tax-efficient tool that can be used to help you accomplish your objectives.
For further information on this topic, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
