As advisors to entrepreneurs and business owners, coupled with our experience in finance and strategy, we would be remiss if we did not bring ESOPs to your purview. They are a valuable investment management tool, and we can assist clients with structuring, managing, and exiting this financial vehicle. Remember, we are attorneys and financial engineers first.
What is an ESOP? Employee stock ownership plans (ESOPs) enable privately-held companies to sell shares to an employee trust. Owners receive fair market value for their equity and can gain significant tax benefits for themselves and their companies. Employees gain a valued retirement benefit (company stock). This is not a stock option plan. Instead, it’s an ERISA-authorized, defined contribution plan that invests in employer securities.
Who’s the buyer? A trust representing at least 10 employees.
Who sets the price? The price is negotiated with an institutional trustee, based on an independent valuation.
How is it funded? Commercial and/or seller financing, paid-off with pre-tax corporate cashflow.
Who gets shares? Full-time employees are allocated shares proportional to their annual compensation.
How is stock earned? A portion of all shares is allocated annually; the shares vest within 3-6 years.
How do employees cash out? Vested stock is sold back to the company, at a current valuation, when employees depart.
Who can benefit from an ESOP?
Owners - Paid fair market value for their business, can defer capital gains taxes on proceeds, maintain upside potential & a role in the company.
Companies - Receive tax deductions on sale amount, can become income tax-free entities, get a tool to retain & attract talent.
Employees - Secure a unique retirement benefit, earn a real stake in their companies, gain workplace stability & peace of mind.
ESOPs are the M&A alternative
Looking for an M&A alternative? You probably have middle market clients who would benefit from a liquidity event but wouldn’t dream of selling their businesses. Whether they’re concerned about damaging their legacy, abandoning trusted employees, or giving up on a potential multi-generational asset, their fears are valid and, at times, stifling. Even if they ultimately settle for a traditional third-party or private equity transaction, the capital gains tax burden can often be painful.
ESOP – A flexible liquidity solution - Employee stock ownership plans offer business owners a tax-efficient opportunity to unlock the net worth tied-up in their companies. A company’s stock is sold to an employee trust at a fair market valuation. The transaction is funded through commercial and/or seller financing. Selling shareholders and their companies can reap tax benefits, maintain the flexibility to make future M&A transactions, and gain a number of additional benefits.
Tax-efficient diversification - By reinvesting their sale proceeds in a Qualified Replacement Property, business owners can defer or eliminate capital gains taxes.
Upside - Owners may continue to hold stock and maintain a meaningful role in the business.
Estate planning - Owners can make gifts of retained interest to family and prepare for estate tax burdens at a time when a company’s value is depressed by leverage.
ESOP – A liquidity alternative - Employee stock ownership plans offer privately-held companies and family businesses a tax-efficient, liquidity opportunity. A company’s stock is sold to an employee trust at a fair market valuation. The transaction is funded through commercial and/or seller financing (often without personal guarantees) and paid-off with pre-tax corporate cash flow. This frees owners’ capital and carries a host of other advantages.
Tax incentives - Selling shareholders can defer capital gains taxes on the proceeds, while their companies can deduct the sale value to reduce taxable income and potentially eliminate income taxes altogether.
Continuity - Post-transaction, a company’s board continues operating the business, while selling shareholders often maintain meaningful roles.
Workforce benefits - Employees gain a unique retirement benefit in the form of stock allocations.