- Thirty years in financial services, involved in M&A, recapitalization, acquisitions and restructuring transactions, in providing senior debt, junior capital and equity to middle market and large corporations.
- Managing Director of CSG Partners focusing on ESOP transactions.
- Senior Vice President of GE Capital Media, Communications & Entertainment unit.
- Founder and CEO of Access Credit Corporation, an equipment finance company specializing in municipal leasing, maritime finance and advisory services.
- Developed a residual option product and was actively involved in acquiring options in excess of $1.5 billion of original value.
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ESOP Feasibility, Design and Implementation
- Owners need more options for exit strategies.
- My firm closed a deal in Oakland a couple months ago. The 47-year-old owner started the business in his bedroom in 2000 and it is now employing more than ninety people and is very profitable. As we stood in front of his employees, he said, “Frankly, the reason I'm doing it is I'd like to get some time off to spend with my family. I feel comfortable with the caliber of management we've got in place, and as a result, you're going to be owners of a percentage of my company now.”
The key issue is whether you have anybody who is capable to step in and carry the business forward if you step out. For companies with younger, competent and stable management, ESOPs combine the financial benefits of a sale with the ability to keep the business growing and prospering. Whether you end up with an ESOP or not, you should at least do the analysis and compare it to a merger or a sale or maintaining the status quo and see what it means to you from an after-tax standpoint. Then you can make a rational and educated decision.
- Owners of a business may have different time frames for an exit.
There is a huge wave of aging baby boomers. Many need to get some liquidity out of a business, if not sell the whole thing. ESOPs are a very viable and highly tax efficient solution. ESOPs are also a very effective wealth transfer tool. Since implementing an ESOP requires debt, you effectively reduce the value of the company by the debt amount. That is a very good time to transfer ownership to your heirs, as it is done under a temporarily lower value.
I worked with a fast-growing company in Southern California that's owned by a father and a son. Each owns 50 percent. The son is young and wants to maintain his ownership, but the father wants to cash out. A merger or sale would have provided a partial solution, but an ESOP was a much better alternative: The father got immediate liquidity. The son continues to lead the company. The ESOP allows management and employees to benefit from the fruits of their labors and become owners in a growing, successful company.
- Changes in tax law require better planning.
- This is illustrated by a recent situation in which a family-owned company was run by two non-family members, the CEO and the CFO. The key power in the family, the father, was suffering from failing health. By putting an ESOP in place, they guarantee that the CEO and CFO are going to stay for the long term. The family owners don't have to pay tax on the disposal of the stock. Without an ESOP, the family might have paid 50 percent of the proceeds in tax. The ESOP allowed the family to share in future upside and ensured that management and employees are going to stay and the company will continue to grow as a tax free entity.
- ESOPs can be expensive to set up.
- People complain about the cost of setting up an ESOP. But it's important to remember that it is subject to review by the Internal Revenue Service and, more importantly, by the Department of Labor. You need to be able to demonstrate that it was a negotiated transaction, that it was done properly, and you got good advice from qualified advisers.
If they come in and find there's no independent trustee, and some unknown entity did the valuation of the shares, and the law firm that advised you has no previous ESOP experience, then they are going to spend a lot of time with you. It has to be done right. It costs money but because of all the tax savings, it's still a very attractive proposition that makes a lot of sense. In many situations, creating an ESOP may result in a significant tax refund for past years, which will offset the transaction cost.
- Companies are required to repurchase shares from departing employees.
- There's one risk – and it's more of a theoretical risk – with an ESOP. That is that every employee is fully vested in the plan and everybody wants to quit that same time. At that point, you'd have to find the cash to pay them all. In reality, though, it doesn't work that way.
If somebody dies, retires, or becomes disabled, you have to start paying them one year after the event, and you have five years to fully cash them out. But if an ESOP participant resigns, you don't have to start paying him or her for five years after the departure, and you have another five years to fully cash that person out. If there is a loan financing the ESOP still outstanding, you don't have to cash out a participant who resigns until after the ESOP loan has been paid in full, which may take quite a few years.