This expertise developed over time has allowed me the ability to assist and give the small business owner options for retirement or exiting their business. An employee stock ownership plan (“ESOP”) is a qualified, defined contribution, employee benefit plan. ESOPs are "qualified" in the sense that the ESOP's sponsoring company, the selling shareholder and
participants receive various tax benefits. An ESOP is very similar to other qualified retirement plans, like a 401(k) plan, with two very significant
differences: (1) the ESOP is designed to invest primarily in the stock of the sponsoring company and (2)
employees don’t use any of their money to acquire any shares. The first ESOP was created in 1957, the tax benefits which make the ESOP so popular were introduced in
1975, and today there are thousands of companies with ESOPs in the U.S., benefitting millions of employees. A leveraged ESOP (“LESOP”) is simply an ESOP that has obtained financing to purchase shares of the
company from existing shareholder or from the company itself. POTENTIAL BENEFITS OF ESOPS
If structured properly, a leveraged ESOP can provide the following benefits:
Customization of many of the transaction terms to fit the situation. For example, each shareholder can sell any
interest they wish to sell – from a minority interest (the ESOP trust must own at least 30% percent of the
Company for favorable tax treatment discussed below) up to 100%, i.e., some shareholders can exit and
others can stay. Contrary to popular belief, for whatever shares are sold to the ESOP, the selling shareholders can receive fair
market value for their shares. Selling shareholders can receive significant cash at closing (amount will be determined by ability of company
to obtain financing). Selling shareholders can permanently defer capital gains taxes on the transaction (i.e., keep the part of the
sale price (usually over 25%, depending on state of residency) that would have to be paid in taxes in a
normal third party sale) if they elect IRC § 1042 treatment and take other appropriate steps discussed herein. Regardless of the amount of interests sold by the selling shareholders they can retain control of the business
post – closing, or vest control in a management team (which could even include next generation family members). The post-closing ESOP company receives significant tax deductions enabling it to pay little or no corporate
taxes and, potentially, to receive refunds of any taxes previously paid. If the ESOP owns 100% of the capital
stock after close, the company becomes what is essentially a for-profit, tax exempt entity.
“Second bite of the apple” for the shareholders or for others the shareholders care about, typically equaling
30-40% of the equity value of the business, consisting of the seller financing warrants and nonqualified
management incentive plan. Employees get a retirement benefit windfall (i.e., not using any of their own money to fund the plan) and they
can defer taxes to later in life when their tax bracket will likely be lower. SALE TO A THIRD PARTY
Due diligence process is less disruptive to business
Transaction is typically handled much more quickly than sale to a third party
Holdbacks, earn-outs and indemnification claims common in third party sales are much less likely in ESOP
transactions
Confidentiality of business operations and trade secrets can be maintained (i.e., no competitors looking at
sensitive Company information)
Purchase price is stable throughout transaction (i.e., no “deal creep”). ESOP transaction can be customized to meet the goals of the selling shareholders. Company culture unchanged in an ESOP transaction
Legacy goals of shareholders can be achieved in an ESOP transaction
SOME ESOP MISCONCEPTIONS
Selling shareholders will lose control to employees
Management or employees will have to fund the purchase
You have to be a particular entity type (e.g., C corp/S corp)
Employees will have access to sensitive company financial information
Sellers will not receive a fair purchase price
An ESOP will prevent a subsequent sale of the company
ESOPs are expensive to set up and/or administer post-closing
To have an ESOP companies need a large payroll
It only works for certain types of businesses
