Transcript Document

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What is an ESOP?
How can you benefit?
Presented by
Timothy J. Cleary
VP - Consulting
The Principal Financial Group®
(952) 543-0980 x318
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ESOP Opportunities
in Estate and Business Succession Planning
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Sample opportunities
What is an ESOP
How does an ESOP transaction work
Benefit for owners to sell to ESOP
Benefit for company – tax savings
S corporation benefit
Common objections
Combining with a GRAT
Review and candidate profile
ESOP Success – No Successor, Inc.
• Small distribution company, owner in late-50s
Facts: • Bought business 20 years ago
• Corporation is primary asset - $7 million
• No children in business
• Interested in retiring in 3 – 5 years
Goals: • Want to take care of employees
• Interested in ESOP
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ESOP Success – No Successor, Inc.
Solution:
• Sold 30% to ESOP, deferred tax on sale
• Gave 10% over 5 years to key employees
• Sell rest in 5 – 7 years
• Started including key employees on
strategic decisions
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ESOP Success – Big Private Co.
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Facts:
Goals:
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30 year old business valued at $185 million
Owned by 2nd generation in late 60’s
2 sons in business, 2 daughters outside
Strong management
Father and one son value employees
Other son wants as much as he can get
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Ready to retire
Management team including sons in control
Liquidity for daughters & life-time
Charitable giving
ESOP Success – Big Private Co.
Solution:
• Sold 100% of stock to ESOP for $135 million
• Gave $50 million to sons & management over
15 years
• Set up estate plan to provide equal value to
daughters
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ESOP Success – Eggs in 1, Inc.
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5 year old marketing firm valued at $8 million
Owned by 2 conservative men in early 40’s
Worth more than dreamed of
Questioning should they sell; don’t want to
No buy sell insurance
• Protection for family
Goals: • Diversification
• Golden handcuffs/Ownership for key employees
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ESOP Success – Eggs in 1, Inc.
Solution:
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Sold 40% to ESOP to get liquidity
Diversified investment for family protection
Sold 5% to key management
Hold the rest of the stock and have fun again
What is an ESOP?
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Employee Stock Ownership Plan
Retirement plan protected by ERISA
Similar to profit sharing or 401(k) match
Two differences:
– Primarily invested in company stock
– Can borrow money to buy stock
• Flexible tax-advantaged tool for many corporate
finance transactions!
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ESOP Success – ABC, Inc.
• Owned by John and Mary Jones, both in early-60s
Facts: • Founded business 25 years ago
• Corporation is primary asset
• Pillar of community
• Interested in retiring in 3 – 5 years
• Want Child 1 to take over business
Goals: • Want equal value for Child 2 outside of business
• Want to take care of employees and local charities
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Contemplating the Exit
Third Party
Family
Selling
Shareholders
ESOP
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Third Party Sale
Third Party
Selling
Shareholders
• Owner pays capital gain tax
• Buyer pays with after-tax earnings
• Owner likely loses control
• Corporate identity?
• Fate of employees?
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Family Sale
Family
Selling
Shareholders
• Owner pays capital gain tax
• Buyer pays with after-tax earnings
• Family retains control
• Business retains identity
• Retain employees
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Benefits for you and your clients
Client
Benefits:
• Liquidity tax free
• Retain control until retirement
• Corporate tax savings pay for liquidity
• Employees own part of business and not pay
taxes until retirement
• Client and key employees protected/insured
Intermediary • Have a very happy client
• Get commissions from several sources
Benefits:
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ESOP Transaction
Tax Deferred Reinvestment
Buy
Stock
ESOP
Loan 2
Selling
Shareholders
Loan 1
Bank
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Company
Requirements for Tax Advantage
• The company is a closely-held C corporation at
the time of the sale
• The seller owned the stock for at least 3 years
• The seller didn’t acquire the stock through an
option or other compensation situation
• The ESOP owns at least 30% immediately after
the sale
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Sellers’ Advantages
• Seller has to reinvest in replacement securities
• Tax on capital gain deferred
• Tax eliminated if hold reinvestment for lifetime
• Products available to hold reinvestment for
lifetime
– Still have use of up to 100% of proceeds
• Savings maybe in excess of 20% of value!
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ESOP Transaction
Tax Deferred Reinvestment
Buy
Stock
ESOP
Loan 2
Selling
Shareholders
Loan 1
Bank
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Company
C Corporation –
Deduction for Principal
Company receives tax deduction
for providing shareholder
liquidity!!!
In other words, tax savings pay
40% of debt!!!
ESOP
Loan
Payment
Deductible
Contribution
Loan Payment
Bank
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Company
Allocation of Stock
ESOP Trust
Participant Accounts
Year 2
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Stock
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For financial professional use only.
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It gets better . . .
S corporation advantage
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S Corporation – Tax Elimination
Tax on shareholder
portion only
NO TAX!!!
ESOP
S dividend
distributions
Non-ESOP Shareholders
Loan payment
Company
Tax savings pay 100% of debt!!!
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Common Objections
• “If it sounds too good to be true, it probably is.”
– Answer: This time it is true. Congress intentionally set up
benefits to encourage employers to provide retirement
benefits and align shareholder and employee interests.
ESOPs are favored by both parties.
• “I don’t want to lose control.”
– Answer: Owner can retain control as trustee and vote all
of the shares in the ESOP on most issues.
• “I don’t want to disclose everything to employees.”
– Answer: Only disclosure required to employees is
standard retirement plan statement – shares and value in
participant’s account.
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Estate Planning . . .
Combine ESOP with GRAT
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Perfect time for GRAT
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GRAT – Grantor retained annuity trust
Gift asset = retained annuity to grantor
No gift tax
S distributions for tax on S income count as
annuity
• If annuity insufficient, transfer part of stock back
• Want to gift when stock value is low, transfer
back when stock value is high
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Use of GRAT with ESOP Sale
ESOP
GRAT for
Family
51%
49%
Company
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Perfect time for GRAT
• Valuation for GRAT immediately after ESOP
transaction:
– Reduce for ESOP debt
– Add back small amount for tax advantage of ESOP
– Reduce 49% transferred to GRAT for minority discount
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Value for GRAT
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Pre-ESOP company value
Less ESOP debt
Plus add back for ESOP
$100
($51)
$15
Post-sale company value
$64
49% value
Minority discount 30%
Discounted 49% value
$31
($9)
$22
Perfect time for GRAT
• Since transfer value is low, S distributions may
equal annuity
• If not:
– Valuation increases as outside debt is repaid
– Outside debt repaid over 5-7 years so value likely to be
higher at end of GRAT period
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ESOP Uses in Private Companies
• Heavy lifting in an exit succession strategy while
providing continuity of management and control
• Partial or complete liquidity for inactive
shareholders
• Create a market for closely held stock
• Acquisition strategy
• Combine with a GRAT in family business
• Reward, retain and attract employees
• Create tax efficient employee-owned company
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Who is a Typical
ESOP Candidate?
• Closely-held C or S corporation
• One or more owners nearing retirement or
wanting liquidity
• History of profitability ($1,000,000 or more)
• Successor management in place or in wings
• Available corporate credit
• Comfortable with sharing value with employees
• Minimum 50 employees
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Review . . .
Great opportunity for you
and your clients!
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ESOP Advantages
• Seller
– Friendly buyer for all or part of the stock
– Tax on capital gain deferred
– Tax eliminated if hold reinvestment for
lifetime
– Seller retains control
– Control fate of company and employees
– Better protection from various risks
– More complete estate plan
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ESOP Advantages
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• Employees
– Ownership at no cost
– No tax until receive distribution from
ESOP or IRA
• Company
– Tax savings pay for all or part of the
seller’s liquidity
– Retain, reward, attract and motivate
employees
ESOP Transaction
Process:
Communication
Building Value
Administration
Seller Investment & Planning
Comprehensive
Design
Documents
Financing
Valuation
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Preliminary
Design
Comprehensive
Financial Analysis
Thank You.
When you think ESOP
Think The Principal
Insurance products and plan administrative services are provided
by Principal Life Insurance Company, a member of the
Principal Financial Group, Des Moines, IA 50392.
©2004 Principal Financial Group®, Des Moines, Iowa 50392-0001
All rights reserved. No part of this presentation may be reproduced or used in any form or by any
means, electronic or mechanical, including photocopying or recording, or by any information
storage and retrieval system, without prior written permission from the Principal Financial Group.
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