The challenges and demands involved with running a business prevent business owners like you from planning their exit strategy. After decades of hard work, a successful owner will sell his/her business for a fraction of its worth. An outside buyer may change everything from your company’s name, to your management to your employee base and more. All you strived to build is now very different.
Employee stock ownership plans (ESOPs) can be your ideal solution for exiting your business. ESOPs offer companies a smooth transition, continuity of management, employee ownership incentive and often carry tax benefits. The company you created remains whole.
What is an Employee Stock Ownership Plan (ESOP)?
Simply stated, ESOPs are a regulated retirement plan in which employees, through the ESOP, become company owners. There is no change in management. Employees do not become the boss. While they are typically represented by a trustee, that trustee’s fiduciary duty is to ensure the company does not act in any way detrimental to the ESOP or to the ESOP’s participants.
What Are the Benefits of an ESOP?
A Smooth Transition
The ESOP can be an ideal business transition plan for you. You can sell as little as 1% of your company or any amount all the way up to 100% to the ESOP. A sale can occur all at once or in stages over time. Your decision.
Your company, its philosophy, its management, its employee base, and its way of doing business stay intact. This rarely happens with an acquisition.
Employee Stock Ownership Plan’s can offer great tax benefits for the selling shareholder and for your company. Congress has enacted tax incentives for ESOPs that make it a very attractive option for business owners like you.
For certain types of corporation, if the sale is at least 30% of total outstanding shares, you can defer federal (and often state) tax payments on their capital gains. Simply invest the proceeds in qualified replacement property (typically US stocks and bonds). As long as you hold onto those investments, no income taxes are due. Your tax basis in your company is probably very low. The savings here can be enormous.
S-Corporations and other pass through tax entities pass the company’s tax burden to its owners. ESOPs are exempt from federal and most states’ income taxes. The cash previously distributed to owners to help them pay their income taxes can now be invested in company growth.
ESOP companies often can deduct contributions and dividends. Contributions can include payments to repay loans financing the purchase from the owner. Naturally, there are IRS and other regulatory limits.
Better Company Performance
Studies show ESOP companies are more productive, faster growing, more profitable and have lower employee turnover. An ESOP gives employees-owners an added incentive to work hard.
An Important Employee Benefit
The ESOP is an exceptional retirement plan for employees. When they retire, they are paid out at fair market value for the shares credited to their ESOP account. Often, an ESOP is a supplement to a 401(k) and other retirement plans.
Is an ESOP a good idea for me?
ESOPs work best if your company consistently produces a positive cash flow. Like all good things, there is a price tag attached. There are one-time setup costs. There are annual expenses ranging from funding the plan for employee withdrawals to administering the plan.
For expert guidance on Employee Stock Ownership Plans, contact JBV at 1-(516)-882-4878 or @KevinJ@JBVal.com
Jennings Business Valuation is a boutique valuation firm with a proven record in assisting clients realize their dreams.