Transcript Slide 1

Uses of Company Stock
In Qualified Plans
Presented by
Benefit Conference of the South
Atlanta, GA
May 14, 2010
Learning Objectives
1. Understand the similarities and differences among
qualified retirement plans holding company stock
2. Learn about the basic structure and uses of Employee
Stock Ownership Plans, including basic plan
provisions
3. Become familiar with the issues regarding posttransaction stock price declines
4. Introduce ROBS, a new plan using company stock
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Agenda
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Compare/Contrast Plans with Company Stock
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Basic Structure and Uses of ESOPs
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Profit Sharing Plans
Stock Bonus Plans
Employee Stock Ownership Plans
Money Purchase & Defined Benefit Plans
Trust ownership
Leveraged & Non-leveraged ESOPs
Basic plan design considerations
Basic KSOP Structure
Stock Drop Discussion
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Qualified Plans Holding Company Stock
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Types of Qualified Plans
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Profit Sharing (401(k) Plans)
Stock Bonus Plan
Employee Stock Ownership Plan
KSOPs
Money Purchase Pension Plan
Defined Benefit Pension Plan
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Where Plans are Used
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ESOPs are used primarily by privately held
companies
PSPs are used by all companies
KSOPs are used by both public and private
companies, but less frequently in private
companies
ESPPs are generally used in public companies
Stock Bonus Plans are not used that frequently
by private companies
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Qualified Plans: Company Stock
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Similarities Among the Plans
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Deductible expense to sponsor, deferred taxation to participant
Participation and coverage rules
Non-discriminatory
Valuation of stock (for private companies)
Differences Among the Plans
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PSPs are diversified, ESOPs, are not; KSOPs are nominally
diversified
Non-ESOP plans are restricted to 10% of assets held in employer
securities unless they meet requirements of an exception (eligible
individual account plans)
Voting of company stock and Put Option for ESOPs
Tax differences for ESOPs
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ESOP Basics
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Essential Points
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Common Transaction Structures
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Non-leveraged ESOPs
Leveraged ESOPs
Other Unique ESOP Considerations
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Trust Structure
Tax Incentives
Plan Design Issues
Post-Transaction items
Primary Drivers / Constraints
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Valuation, borrowing, ESOP technical
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What is an ESOP?
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“Employee Stock Ownership Plan”
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Qualified retirement plan under IRC
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Company funded benefit - no employee contributions
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Employees do NOT own the stock
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A qualified retirement plan that can borrow money
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Tax-efficient and controlled means of selling stock
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Why Use An ESOP?
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To make a market for part of the owners’
stock
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To defer payment of capital gains taxes
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To borrow where the interest AND principal
payments are tax-deductible
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To transact internally
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To motivate, retain and reward employees
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ESOP Trust Ownership:
Beneficial vs. Direct Ownership
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Shares purchased by the ESOP are owned in
trust, not by plan participants directly
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An independent trustee represents the
interest of ESOP participants
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Company Structure Pre-ESOP
Shareholders
Non-ESOP
Shareholders
elect
Board of Directors
appoints and oversees
President and CEO
hires and oversees
Management Team
hires and oversees
Employees
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Company Structure After ESOP
Shareholders
ESOP Trust
are
represented
by
Non-ESOP
Shareholders
elect
selects
ESOP
Participants
Board of Directors
appoints and oversees
President and CEO
hires and oversees
ESOP
eligibility
requirements
are met
Management Team
hires and oversees
Employees
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Common ESOP
Transaction Structures
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Non-Leveraged ESOP: Pay-as-You-Go
XYZ Corp

ESOP
$ Cash Contribution
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x% of Shares
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$ Cash
Seller(s)
(Taxable Transaction)
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Non-Leveraged ESOP: Pre-Funding
$200,000
Year 1
ESOP
Year 2
$1,000,000
$300,000
$1,000,000
Year 3
Stock
XYZ Corp
$500,000
Seller(s)
(Taxable Transaction)
Stock
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Leveraged ESOPs
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Owner wishes to sell a large block of stock to
the ESOP
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Does not want to pay capital gains taxes
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The company has “debt capacity”
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The Leveraged ESOP
XYZ Corp
Cash
Bank
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
Note Payable
Note Payable
Cash
ESOP

% of the
Outstanding
Shares
Owners
Stock
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Paying for the Stock
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The company will make annual tax- deductible
contributions to the ESOP
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The ESOP will use the contributions it receives
to make P&I payments on the debt that it
borrowed from the company
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The company will use the principal and interest
payments that it receives from the ESOP to
make P&I payments to the financial institution
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Company & ESOP Pay Off Debt
Bank
XYZ
Term Loan Repayment
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
ESOP
Term Loan Repayment
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1. Company makes taxdeductible contribution and
dividends to the ESOP
2. ESOP uses the contribution to
repay its loan from company
3. Company repays bank
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Effect of ESOP Paying off Debt:
ESOP Shares Are Allocated to Accounts
Suspense Account
ESOP uses annual contribution to pay its
note – this “releases” shares from suspense
account
Next year, new employees enter ESOP
ESOP receives contributions and
dividends/distributions from the company
and then pays for more shares
Process repeats annually until all ESOP
shares have been put into accounts
Sandy
Len
Tom
Pam
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Unique ESOP Attributes
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Seller Benefit
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Company Benefit
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Indefinite deferral of capital gains tax
Tax deductions for ESOP debt service - Interest
AND principal
Employee Benefit
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Company funded, deferred retirement income for
employees
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Seller Tax Benefit:
Capital Gains Tax Deferral
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Sale of stock in S-corp ESOP is taxable
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Sale of stock in C-corp (at time of transaction) may
qualify for deferral of capital gains taxes
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Tax deferred sale rules include:
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ESOP must own at least 30%
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Seller must have owned the stock for 3 years
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Seller must reinvest the proceeds within 12 months in
“Qualified Replacement Property”
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Seller must file IRC 1042 election forms with next tax
return, telling IRS deferral has been taken
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Company Tax Benefit:
Pre-Tax Debt Financing
“Regular”
ESOP
Gross Principal Payments
Value of Principal Tax Deduction
Net After-Tax Principal Paid
1,800,000
0
1,800,000
1,800,000
(720,000)
1,080,000
Gross Interest Payments *
Value of Interest Tax Deduction
Net After-Tax Financing Cost
378,000
(151,200)
$2,026,800
280,800
(112,320)
$1,248,480
Net Cash Savings Using ESOP
$ 778,320
38% Savings
Assume:
Principal: $1.8 million, Interest Rate: 6%, Amortization: 6 equal annual payments, Tax Rate: 40%
* Cash tax savings applied to prepay principal, thereby reducing interest expense.
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Employee Benefit:
Deferred Retirement Income
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Company funded benefit
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Deferred taxation
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Typically, no employee funding
Generally taxed at retirement
Employees’ benefit is driven by the value of
the company – for better or worse
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ESOP Plan Design Issues
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Eligibility
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Stock allocations
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Vesting
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Benefit Distributions
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Voting of company stock
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Trustee and governance
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Ongoing ESOP Items
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Annual appraisal update
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Annual recordkeeping and administration
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Repurchase obligations
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Communications training and education
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Legal compliance
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Primary ESOP Constraints
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Estimating company value
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Estimating transaction capacity
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Valuation methods
Debt and borrowing capacity
Evaluating ESOP technical issues
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Company and ownership structure
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What is a KSOP ?
401(k) + ESOP = KSOP
A qualified retirement plan that combines an employee stock ownership
plan (ESOP) with a 401(k). Under this type of retirement plan the
company will match employee contributions with stock rather than cash.
Why?
 Benefits of an ESOP, plus investment diversification
 KSOPs provide added motivation to employees to ensure profitability of
the company (employee-owners)
 KSOP is a financing technique that creates a market with sufficient
liquidity needed for other shareholders wishing to sell their stake
 KSOPs benefit companies by reducing expenses that would arise by
separately operating an ESOP and 401(k) retirement plans
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Is Company Stock a Bad Idea?
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What is the purpose of offering stock in a retirement
plan: retirement or investment?
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Did Congress promote the concept?
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Qualifying Employer Securities
Employee Stock Ownership Plans
Why then?
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Encourages employee involvement in corporate
affairs
“Employee owners have a different attitude about their company, their job, and their
responsibilities that make them work more effectively, and increases the likelihood
that their company will be successful”.
J. Michael Keeling, President
Employee Ownership Foundation
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Did You Know?
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20 million Americans own employer securities
There is considerable evidence that broad-based employee
ownership, especially when combined with participative
management, improves corporate performance
Difference in Post-ESOP to Pre-ESOP Performance
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Annual sales growth
+2.4%
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Annual employment growth
+2.3%
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Annual growth in sales per employee
+2.3%
ESOPs are more likely to still be in business several years later
Source: National Center for Employee Ownership
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Stock Drop Discussion
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Fictitious Stock Example
401(k) Plan = $100,000,000
Value of Plan Stock = $25,000,000
Mary Smith = $50k stock/$50k
diversified
-20%
+10%
Current – 52.5
52 Week Hi-Lo – 65 / 48
Average Daily Volume – 2,000,000
 Potential Stock Drop Case?
 Mary Smith asserts Stock Fiduciary Should Have
Known…?
 Plaintiff Names All Plan Fiduciaries individually,
Senior Management and Board Members
 Appoint Investment Fiduciary
 Stronger defense with trenches built
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Fiduciary Governance
Board of Directors
Executive
HR
Business Considerations
Finance
Legal
Participant Considerations
Non-Public Information
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Fiduciary’s Monitoring Model
Monitor
Trigger Events
Action
Fiduciary
Decision Point
Thresholds
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Fiduciary’s Monitoring Model: Directed Trustee
Review
Monitor
Monitor
Trigger Events
Trigger Events
Company
Fiduciary
Thresholds
Directed
Trustee
Thresholds
Decision Point
Duty to Inform
Action
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No Conflicts
Reasonable Fees
Monitor Fiduciary
ERISA Safe Harbor
Fiduciary’s Monitor Model: Investment Fiduciary
Monitor Investment
Action
Monitor
Trigger Events
Decision Point
Thresholds
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ROBS Introduction
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Rollover for Business Start-Up
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A version of a qualified plan used to access accumulated tax-deferred
retirement funds, without paying taxes, to start up a new venture
Basic Structure
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Entrepreneur forms a new C-corporation (“Newco”) but issues no stock
(Newco has no employees or assets)
Newco hires entrepreneur (sole employee) and adopts a prototype PSP
and adopts an amendment allowing it to invest 100% of its plan assets in
employer securities
Entrepreneur then executes a rollover from prior qualified plan to the
Newco plan and allocates 100% of the asset to the sole employee
Company then issues all of its capital stock to PSP in exchange for PSP
assets at book value. Company now has the cash to grow and invest.
Plan is thereafter amended to prohibit future investments in employer
stock or
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IRS Issues Guidelines 10/1/2008
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IRS issues field guidelines for creating ROBS after
seeing many abuses of the defined contribution plan
rules
IRS primary concern
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Abuses in plan rules and operations that result in non-payment of
income and excise tax penalties that might otherwise be payable
Questionable Plan Practices
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Non-discrimination failure and coverage
Valuation of plan asses
Prohibited transactions
Others concerns: Permanency, exclusive benefit, inactivity
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Contact Information
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Howard Kaplan, Reliance Trust Company
[email protected], (404) 965-7227
1100 Abernathy Road
Northpark Building 500, Suite 400
Atlanta, GA 30328
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Bob Massengill, SES Advisors, Inc.
[email protected], (973) 540-9200
6 South Street, Suite 202
Morristown, NJ 07960
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Thank you.
QUESTIONS?
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