Transcript Document

ESOPs 101
Presented by:
Roy A. Farmer
Business Transition Advisors
Full Service ESOP Plan
Implementation Services
 Preliminary Analysis
 Feasibility Studies
 Plan Design
 Transaction Design
 Financing
 Repurchase Liability Studies
 Employee Communications
 Post Transactional Services
Team Approach
Banker
*
Corporate
Counsel
*
Repurchase
Obligation
Company
CPA
*
Plan
Design
ERISA
Counsel
*
BTA
Team
Coordinator
Employee
Communication
Insurance
Investments
*
Estate
Planning
Stock
Valuation
*
* Outside service provider
Presentation Agenda
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Background & History of ESOP’s
Unique Features
Case Study – Comparisons
How a Typical ESOP Works
Owners Tax Deferral – IRC § 1042
Corporate Governance
Summary of Benefits
BTA’s Role
Moving Forward
Background and History
What is an ESOP?
• A tax qualified defined contribution
employee retirement plan
• Qualifies under IRC Section 401(a)
and Section 4975(e)(7)
• Overseen by the IRS and the
Department of Labor
ESOP Statistics
• Modern ESOPs came into being with
passage of ERISA-1974
• 10,000 ESOP companies in America
today
• Almost 1 Trillion in Assets Held
• This includes companies large and small
Companies
• 21% of all U.S. private sector workers own
company stock
• Wal-Mart, Lowes, Charles Schwab,
Southwest Airlines, Morgan Stanley,
Motorola, Publix
Unique Features
• Must invest primarily in employer stock
• Can use borrowed funds (leverage)
• No employee contributions generally
allowed
• Stock sold to ESOPs can qualify to defer
capital gains tax – certain rules apply
• Contributions can vary year to year, unless
borrowed funds are used
Applications of ESOPs
 Two Primary Applications
 Liquidity for Closely Held
Stock
 Business Owner Transition
Planning
 Also Used In
 Partner Buy Outs
 Owner Diversification
 Divorces
Uses of ESOPs
 “Golden” Handcuffs for
Employees
 Share Equity with
Employees
 Provide Enhanced Benefits
to Employees
Business Owner Concerns
• Must have a “transition” plan
while they are alive and healthy
• Develop personal exit strategy
• Minimize personal and
corporate taxes
• Provide for Management
Succession
• Diversify and have estate
liquidity
• Leave a legacy
Options
Your options depend upon
the objectives and time
horizon
1. Company Stock
Redemption
2. Management Led Buyout
3. Third Party Sale
4. Sale to an ESOP
Selling Shareholder Options
Stock Redemption
Company Value
Value of
Discount applied
Post Discount Value
Profits required to redeem stock (divide by .6)
Tax on Profits @40%
Proceeds to Seller
Capital gains tax
Net to Seller
Total Taxes
Ratio of Net Proceeds to Gross Proceeds
51%
0%
0.6
40%
20%
$10,000,000
$5,100,000
$0
$5,100,000
$8,500,000
$3,400,000
$5,100,000
$1,020,000
$4,080,000
$4,420,000
48%
Selling Shareholder Options
Management Payout
Company Value
Value of
Discount Applied
Post Discount Value
Bonus required to buy shares
Individual Tax on Bonus
Proceeds available to Pay Owner
Owners Capital Gains Tax
Net Proceeds to the Seller
Total Taxes
Ratio of Net Proceeds to Gross Proceeds
51%
0%
0.65
35%
20%
$10,000,000
$5,100,000
$0
$5,100,000
$7,846,154
$2,746,154
$5,100,000
$1,020,000
$4,080,000
$3,766,154
52%
Selling Shareholder Options
Sale to a Third Party
Company Value
Value of
Discount Applied
Post Discount Value
Typical Transaction Fee (8%)
Net Sales Price
Owners Capital Gains Tax
Net Proceeds to seller
Ratio of Net Proceeds to Gross Proceeds
51%
0%
8%
20%
$10,000,000
$5,100,000
$0
$5,100,000
$408,000
$4,692,000
$938,400
$3,753,600
74%
Selling Shareholder Options
ESOP
Company Value
Value of
Discount Applied
Post Discount Value
Estimated Transaction Fee (2.5%)
Net Sales Price
Capital Gains Tax (assuming 1042)
Net Proceeds to the seller
Ratio of Net Proceeds to Gross Proceeds
51%
0%
20%
$10,000,000
$5,100,000
$0
$5,100,000
127,500
$4,972,500
0
$4,972,500
98%
Comparison
Stock Redemption
% of Sale
Management Buy-Out
% of Sale
Sale to a Third Party
% of Sale
Sale to an ESOP
% of Sale
$4,080,000
48%
$4,080,000
52%
$3,753,600
74%
$4,972,500
98%
How It Works
The Company
Company
Adopts an
ESOP Trust
ESOP Trust
How It Works
Lender
Loan
Payment
The
Company
L
O
A
N
C
A
S
H
ESOP
Trust
P
A
Y
M
E
N
T
How It Works
Lender
Loan
Payment
The
Company
L
O
A
N
C
A
S
H
ESOP
Trust
P
A
Y
M
E
N
T
IRC §
1042
Cash
Selling
Shareholder
How It Works
Lender
Loan
Payment
The
Company
L
O
A
N
C
A
S
H
ESOP
Trust
Beneficial
Ownership
IRC §
1042
P
A
Y
M
E
N
T
Cash
Stock
Cash
Selling
Shareholder
Employees
How It Works
Lender
Loan
Payment
The
Company
L
O
A
N
C
A
S
H
ESOP
Trust
Sinking
Fund
Beneficial
Ownership
Death, Disability, Retirement, Termination
and Diversification
IRC §
1042
P
A
Y
M
E
N
T
Cash
Stock
Cash
Selling
Shareholder
Employees
IRC § 1042 Requirements
 Must Be a “C” Corporation
 ESOP Must Own Minimum of
30%
 Shareholder Must Have
Owned Stock for 3 Years
 Shareholder Must Purchase
Qualifying Replacement
Property (QRP) with 12
Months After Transaction
Qualified Replacement Property
(QRP)
Eligible
Public or Private*
•Common Stock
•Convertible Bonds
•Corporate Fixed
Rate Bonds
•Corporate Floating
Rate Notes
•
•
•
•
•
Ineligible
Municipal Bonds
US Gov. Bonds
Mutual Funds
Foreign Securities
REITs, Bank CDs
Eligible issuer must have:
More than 50% of its assets used in the active conduct of a trade or business, no more than 25% of its gross
income from passive sources
One Possible QRP Strategy
Sale of Stock
to Qualified
ESOP Trust
Cash
Portfolio of
40+ Yrs
Floating Rate
Notes
Income from
Bonds
Quarterly
Income
Leveraged QRP Strategy
Proceeds
from Sale
Cash
Portfolio
Floating
Rate Notes
Balance Income with
Interest
Margin
Account
QRP can be
margined to 90%
Liquid
Cash
Leveraged QRP Strategy
Proceeds From Margin Loan
New
Home
Cars
Boat
Stock
Bonds
Corporate Governance
IF YOU CONTROL THE BOARD OF
DIRECTORS YOU CONTROL THE COMPANY
Corporate Control
 Shareholders Elect the Board
of Directors
 Board of Directors appoints the
Officers
 Officers responsible for day-today operations
Corporate Governance
Privately Held Company
IN AN ESOP:
Board of Directors Appoints
the ESOP Trustee
The Trustee Votes the Stock
Control Can Remain
“Undisturbed”
Owners with
Stock Outside
the ESOP
Votes
Board of
Directors
Appoints
“Directed”
Trustee
Corporate Governance
Privately Held Company
Trustee is the owner of the
stock, not the Employees
Trustee votes the stock
 Participants “advise” trustee
only on Mergers, Sale or
Business, Recapitalization or
Liquidation
Corporate Governance
Privately Held Company
• The ESOP is a “passive shareholder”
• Employees are not shareholders
and do not gain Statutory Minority
Shareholder Rights
100% “S” Corporation ESOP
• Pays no Federal corporate income tax
• Taxed like a partnership – net income
flows through to the shareholders –
ESOP, No Tax
• Exempt from prohibited transaction
rules
• Doesn’t have to distribute stock
Qualitative Benefits
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“Golden Handcuffs” for key People
Reduced Turnover
Reduced Worker Comp Claims
Greater Productivity
Greater Profitability
Greater Commitment to the
Company
• Better Work Environment
Summary of Tax Benefits
• Deferral and/or Avoidance of
Capital Gains Taxes on the Sale of
Stock
• Deduction of the Full “Fair Market
Value” of the Stock Purchased by
the ESOP
• Possibility of becoming “Tax Free”
as a 100% “S” Corporation ESOP
WIN-Win-Win For Everyone
Business owners
Employees
Corporations
• that are more advantageous
• than any other single
vehicle
BTA’s Role
• Next Steps:
Feasibility Analysis
Presentation to the Client
Sufficient Information to
Determine Direction
Move to Full Implementation