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The Benefits of an ESOP
Employee stock ownership plans (ESOPs) offer valuable incentives to all stakeholders. Beyond shareholder liquidity, employee wealth-building opportunities, and continued company autonomy, these business transition strategies deliver unique tax advantages.
Get our full report on ESOP tax benefits.
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Unlock Net Worth
Creates a tax-advantaged, liquidity event and diversification opportunity for selling shareholders.
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Free Cash Flow
Yields lucrative tax-breaks for the business; 100% employee-owned companies can operate income tax-free.
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Reward Employees
Full-time staff gain stock over time, which can provide stability and a chance to share in corporate growth.
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Sustain Legacies
Selling shareholders can maintain a meaningful role with their company and potential upside.
ESOPs AS M&A ALTERNATIVES
How do ESOP sales differ from other transactions?
ESOPs offer privately-held companies continued independence, unique tax advantages, and employee benefits. Post-transaction oversight of an employee-owned business rests with the firm’s board of directors, and selling shareholders often maintain meaningful roles.
Are certain companies better suited for leveraged ESOPs?
Leveraged ESOPs are industry-agnostic, but private companies with taxable income and at least 10 employees are generally better candidates. Common use cases include family business ownership transitions, management buyouts, partner exits, and partial liquidity events for owners who want to stay with their companies.
How do selling shareholders receive cash at close?
Many third-party lenders, including major banks and funds, help finance leveraged ESOPs. These loans are secured by plan sponsors on behalf of their employee trusts. Senior debt, without personal guarantees, is commonly used to provide up-front cash to sellers. Seller notes are also a standard ESOP financing component.
TAX ADVANTAGES
What is a 1042 Rollover?
An ESOP-exclusive benefit, this tax-deferral strategy enables selling shareholders to defer and potentially eliminate capital gains burdens on their sale proceeds. To earn the benefit, a seller must reinvest their proceeds in Qualified Replacement Property within 12 months of their ESOP transaction date.
Can employee-owned companies earn tax incentives?
Yes. When shares are transferred to an employee stock ownership trust, sponsor companies may earn state and federal income tax deductions equal to the fair market value of that stock. In addition, 100% ESOP-owned S corporations can become income tax-free in perpetuity.
Are employee owners entitled to tax benefits?
ESOP participants can roll plan benefits into other tax-deferred retirement accounts, including 401(k)s and IRAs. Rollovers must be completed within 60 days of a plan distribution. Otherwise, distributions and dividends are subject to standard taxes and early withdrawal penalties.
FORMING A LEVERAGED ESOP
Typically, what is the first step in a plan formation?
Interested companies often commission a financial analysis and feasibility study, led by an experienced advisor. This work can help stakeholders quantify plan benefits and costs, review structuring options, ascertain fair market valuation, and appreciate the overall viability of a potential ESOP.
How is a trustee selected?
Ideally, a selection committee, designated by the sponsor company’s board and comprised of key employees, will select the trustee. An interview process featuring several qualified candidates is typical. To determine best fit, the committee will consider multiple factors, including candidates’ independence, experience, and competence.
How is an ESOP sale price determined?
A sponsor company and its ESOP trustee negotiate final transaction pricing. An employee stock ownership trust cannot pay more than fair market value, an IRS standard that is typically a composite of discounted cash flow modeling, public market comparisons, and precedent transaction analysis.
MANAGING ESOP-OWNED COMPANIES
What is an ESOP trustee’s role?
A trustee is the employee stock ownership trust’s shareholder of record. They have a fiduciary obligation to all plan participants. During an ESOP formation, a trustee represents and negotiates on employees’ behalf. Post-transaction, they ensure the ESOP’s terms are followed and executed by the plan’s sponsor.
Who runs an ESOP-owned business?
The company’s board of directors oversees management and operations. The ESOP trustee typically does not serve on the board. Instead, the trustee maintains an oversight role and votes the employee-owned shares in the event of a major transaction, such as a sale, merger, acquisition, or recapitalization.
Can a plan be modified or terminated?
Yes. With a trustee’s consent, plan terms can be modified. In addition, ESOP financing can be restructured, and follow-up transactions—including secondary sales, stock repurchases, and plan terminations—are common. Under certain circumstances, a sponsor company’s board of directors can replace a plan’s trustee.
