ESOP

Discover the advantages of an Employee Stock Ownership Plan

You’ve worked hard for the success you’ve achieved, so it’s important that you establish a transition strategy to help ensure a financially successful exit. If you would like to sell your business, you may find you don’t have an obvious successor. And if you care about the longevity of your business, the company culture you’ve created, and the welfare of your employees after the sale, there could be a solution to help address these considerations. An Employee Stock Ownership Plan (ESOP) can help you sell your business, take care of your employees who participate, and provide you and your key employees with tax advantages along the way

An ESOP is an employee benefit plan that is set up as a trust and gives key employees ownership interest in the company. As a qualified pension plan, an ESOP permits the plan trustee to purchase shares of an employer’s stock. Shares are allocated to each plan participant’s account and, at retirement, the stock is usually sold back to the employer for cash to fund the retirement benefit.

1. Your company forms a trust and establishes the ESOP.

2. Your company may take out a loan and lend the proceeds to the ESOP.

3. The plan trustee buys out some or all of your shares in the company.

4. During the valuation process, a “repurchase liability study” is usually performed to calculate the plan’s liquidity needs to buy out participants who will retire in the future. In the early years, the ESOP may not have enough liquidity and therefore may have to use loans.

a. To assure an arm’s length transaction, an independent appraiser values the company, and the ESOP hires an independent trustee.
b. Life insurance is usually purchased on the older and/or major stockholders as a funding vehicle for the future “repurchase liabilities” of the plan.

5. The loan is repaid by having your company make income tax-deductible contributions to the ESOP.

6. The plan trustee uses corporate contributions to repay the loan made by your company, and your company uses the same dollars to repay the lender.

7. Stock is held in a suspense account in the trust and is only allocated to plan participants as the loan is repaid

• An ESOP provides you with a buyer for your company, yet enables you to remain active in managing the business.

• The ESOP helps you attract, retain, and motivate top talent — and it gives your participating employees a culture of ownership.

• The ESOP can be funded with pre-tax dollars, and loan principal amounts are deductible.

• Depending on your corporate structure, you may be able to defer capital gains on the sale.

An ESOP won’t work in every situation. But your company may wish to consider this strategy if it is financially strong, with ongoing revenue streams, a strong management team, and employees who are willing to share ownership in the company.

The ESOP repurchase obligation is the liability created when vested participants are entitled to receive distributions from the plan. The usual repurchase triggers are retirement, death, disability, termination (voluntary and involuntary), and the option to diversify.

Funding options for the repurchase obligation include:

• Pay as you go (i.e., no funding)

• Loans

• Sinking fund, either owned by the ESOP or the corporation outside the ESOP

• Life insurance, either owned by the ESOP or the corporation outside of the ESOP

Purchasing permanent life insurance on the older and/or major stockholders as a funding vehicle for the future repurchase liabilities of the plan can be more cost effective than having your company fund the obligation through current cash flow, or through the use of a loan.