Transcript (ESOP). - HR.com

Succession Planning: The ESOP Solution
Thomas Roback, Jr., CEP, QKA
Managing Director
Blue Ridge ESOP Associates
434.220.7947
[email protected]
June 2012
I. About Blue Ridge ESOP Associates
About Blue Ridge ESOP Associates
Over 24 Years of Experience
 Established in 1988
ESOP Administration Experts
 ESOP Administration is Our Primary Business
 One of the Top Four Firms in the US in Number of Clients and
the most interactive on-line tools in the industry
Professional Staff with a Focus on Outstanding Client Service
 Directors and Managing Directors with 15 to 25 years of
experience
 Administration Staff with Professional Designations
 Dedication to Providing Outstanding Client Service
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II. What is an ESOP and Why Consider Putting
an ESOP in Place?
ESOPs: A Solution for Private Business Succession
At any given time, about 40% of closely-held U.S. businesses are
looking for a transfer of ownership solution.
Less than 1/3 of closely-held family businesses survive the transition
from first to second generation ownership.
Plans are unclear for CEOs who are:

Retiring in five years – 42% have no identified successor.

Age 60+/- 28% have no successor.
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Closely-Held Clients Need Help With Ownership Transition
Most hope to cash out or transfer the business to family members.
In either case, your autonomy may be at risk.
Brokers and M&A specialists prey on business owners with promises –
which cannot always be kept.
You need unbiased strategic counsel to provide integrated options and an
understandable process to achieve desired continuity goals.
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Percent of Business Owner Net Worth
Business
Outside
Wealth
Age 40
Business Growing
Business
Outside
Wealth
Age 50
Business Successful
Growth is Taxed
Business
Age 65
Business Transition
Transition is Taxed
And Death is
Taxed
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Outside
Wealth
Reasons Why Owners Fail to Successfully Transfer Their Business
Lack of viability of the business.
Reluctance by owner to give up control.
Reluctance of next tier management or family members to
take the helm.
No real buyers.
Adverse tax consequences.
Lack of planning, the primary cause for failure.
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Integrated Planning Process
Vision, Values, Goals
1
PRELIMINARY
INTERVIEW
5
2
MANAGEMENT
PHASE
DISCOVERY
PHASE
4
3
IMPLEMENTATION
PHASE
DESIGN
PHASE
Strategies and Products
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Comprehensive Planning Approach
BUSINESS
INTERESTS
1.
2.
3.
4.
CREATIVE
PLANNING
OVERLAP
Shareholder Considerations
Executive Benefits
Company Considerations
Employee Benefits
PERSONAL
INTERESTS
1.
2.
3.
4.
5.
Cash Flow
Tax Planning
Wealth Management
Wealth Distribution
Personal Legacy
Decisions should be made in the context of the complete picture.
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Options/Structures Available to Business Owners
Close/liquidate the business.
Gifts of stock, charitable trusts, and/or private foundation.
Sell to an outsider.
Sell to insiders (management, family members and/or employees).

Family limited partnership.

Installment sales to family members or rising management.

Employee Stock Ownership Plan (ESOP).
Retain ownership but hire outside management and keep taking a
paycheck or establish deferred compensation arrangements.
A combination of the above…
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PRIVATE CORPORATIONS
Taxes impacting companies, their owners, and families
• Corporate income taxes
• Personal income taxes
• Capital gains taxes
• Gift taxes
• Estate taxes
• Generation skipping taxes......
These taxes are seldom addressed in an integrated fashion
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The Vanilla Private Company Deal: Selling to Management
• The rising manager(s) are not usually high net worth individuals.
• “OK, we’ll bonus her the money and she’ll buy our stock.”
• $100,000 bonus to a rising manager – manager pays $40,000 taxes,
leaving $60,000 for stock purchase.
• Manager buys $60,000 of stock from shareholder: shareholder pays
$10,000 capital gains tax (increase after 2012?)
Outcome: Government $50,000 - Owner $50,000
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Sale of Stock to Outside Buyer
Complete sale of stock to an outside purchaser.
Partial sale of stock to outside purchaser

New purchaser generally will purchase enough to gain control.

Minority stockholders then have limited powers.
Tax consequences of sale

Long-term capital gain treatment vs. ordinary income.
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Sale of Stock to Corporation (Redemption)
Sale must not impair capital of the corporation or cause it to become insolvent.
Corporate redemption reduces the number of issued and outstanding shares (antidilutive): may alter control and share valuation post transaction.
Tax Consequences to the selling stockholder

May qualify for capital gain treatment or may be treated as dividend.
Tax consequences to the corporation

No taxable gain to the corporation unless it uses appreciated property in
redemption.

Stock acquired with after-tax dollars

Interest paid on Promissory Note is generally tax-deductible.
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Which approach can do all of the following?
 Maintain ongoing company
 Provide a competitive advantage
 Allow for tax-advantaged sale by owner
of all or part of the business
The Answer… an ESOP!
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What is an ESOP?
A defined contribution retirement plan
that is qualified under federal tax law
(Sec. 401(a)) and is primarily invested in
company stock.
Similar rules for eligibility and vesting as
other qualified plans.
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Benefits of an ESOP
 Company remains intact
 Significant tax advantages
 Added benefit to employees
 Benefit linked to company
performance
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III. ESOP Mechanics
How To Create An ESOP
 Conduct a Feasibility study
 Hire Independent Appraiser to determine FMV
for the company’s stock
 Consult with an Attorney on ESOP plan
design/fiduciary issues and preparation of trust,
plan, and related documents
 Hire ESOP Administration firm
 Appoint the ESOP Trustee
 Proceed with implementation and sale
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Leveraged Transaction - Variations
Company Loan
Company
Company
Loan Payments
ESOP
Loan
Payments
Cash
Contributions
Selling
Shareholders
Bank
ESOP
Loan
Cash
Common Stock
ESOP Trust
Stock
Allocation
s/
Distributions
QRP
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Employees
Non-Leveraged Transaction
Company
Cash
Contributions
Selling
Shareholders
Cash
Common Stock
ESOP Trust
Stock
Allocation
s/
Distributions
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Employees
IV. ESOP Tax Incentives
ESOP Tax Incentives
 Owner
 Selling C Corp. shareholder(s) may defer capital gains taxes on sales of stock to an ESOP
(“Section 1042 Rollover”) if reinvest in QRP within 12 months from sale.
 If seller note, can use installment treatment on payments.
 Can take below market interest rate in exchange for warrants.
 If no section 1042 election, owner can participate in ESOP if still an employee.
Company
 Contributions to ESOP are tax-deductible (generally 25% limit, but separate 25%
for other DC plan of C Corp.).
• Contributions to the ESOP to repay both principal and interest on ESOP loan (not just
interest).
• C Corp. dividends paid to participants or used to pay ESOP debt deductible.
• C Corp. ESOP loan interest do not count toward section 404 limit
 Employees
 Contributions and earnings thereon to ESOP accounts are tax-deferred until distribution.
 Special section 415(c) rules for C Corp. ESOPs. Forfeitures & interest on loan repayment
excluded if < 1/3 ESOP contribution goes to HCEs.
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Tax Incentives continued…
An ESOP’s portion of the income earned by
an S Corp. is not taxable.
 Since there are no federal taxes on an ESOP’s share
of S Corp. income, a 100% S Corp. ESOP does not
need to make distributions to shareholders to pay
these taxes. Enhanced cash flow!
Downside – No section 1042 rollover permitted.
However, can do deal as C Corp., then switch to an S
Corp., or if S Corp. can switch to C Corp. and do
deal and then change back to S Corp. after 5 years.
Separate “anti-abuse” testing under section 409(p)
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Distributions (Repurchase Liability)
Small account balances typically paid in lump sum
after year of termination
Other payments typically start 6th years after
termination or 1 year after retirement/ death /
disability
 Participant may delay distribution until age 65
 Paid in cash lump sum or in annual installments up to
5 years
Distributions taxed as ordinary income unless rolled
over into an IRA
In C Corp. leveraged transactions, distributions
typically delayed until the loan is paid off
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Current ESOP Statistics from the NCEO*






The National Center for Employee Ownership estimates that as of 12/31/11
there are about 10,900 ESOPs
There are over 10 million employee-owners
The % of ESOP companies in manufacturing has declined to about 17%
Construction (9%), and professional/scientific/technical firms (15%) have held
steady through the 2000s
Finance/Insurance/Real Estate has declined to about 16%
The % of leveraged ESOPs has declined to about 32%
*Employee Ownership Report, April 2012, NCEO.
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Current Events in the ESOP World







Congressional impasse on most issues, but ESOPs are generally something both
sides of the aisle can agree on
2010 General Social Survey found that only 2.6% of employee-owners reported
being laid off in the previous 12 months, compared to 12.1% of non-employeeowners. Aslo, 24.3% of non-owner employees intend to lok for a new job in the
near future, while only 12.9% of employee-owners do.
Georgetown Business School study showed that in the most recent recession, S
Corp. ESOP companies showed resilience and performed better than other
companies in providing for workers' retirement security, job creation, and revenue
growth.
2010 TEA/EOF survey showed the average age of ESOPs to be 15 years and the
average account balance $195k!
83 million Baby-Boomer business owners are starting to think about retirement
and an ESOP could be the right solution
May see some business owners sell before 12/31/12 to lock in low 15% capital
gains rate
§1042 may become more fashionable in 2013 and beyond with higher capital
gains rate
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Q&A