The term ESOP is an acronym for an Employee Stock Ownership Plan. Just like any other qualified retirement plan, the sponsoring company makes tax deductible contributions to the ESOP for the benefit of the employees.
Unlike other plans, these contributions are used to acquire stock in the employer company. An ESOP provides an exit strategy for the company’s shareholders.
Smart Business spoke with Walter McGrail, a principal at Cendrowski Corporate Advisors LLC, regarding the benefits of adopting an ESOP in your business.
What are the benefits of adopting an ESOP?
There are several benefits to consider when deciding whether to adopt an ESOP.
Most people think of the tax considerations as the employer receives a deduction for making contributions to an ESOP, just like it would if it made contributions to a 401(k) plan. Employees can continue to make tax-deferred contributions to the ESOP, just like a 401(k). Owners of C corporations can completely avoid income tax on qualified sales of stock to an ESOP.
Sponsoring employer companies are able to shelter earnings from income tax. Aside from tax benefits, the single most influential consideration in deciding whether to adopt an ESOP is that an ESOP stands ready, willing and able to buy shares of your company.
A company doesn’t need to identify potential shareholders or a market through brokers. If a company has an employee workforce in place, it has a potential buyer for its shares.
How does an ESOP work?
An ESOP is established by the employer company.
The company’s shareholders sell their shares to the ESOP. The selling shareholders can provide seller-financing for all or a portion of the purchase price. To the extent that the sponsoring company has access to bank financing, the company can borrow funds to loan funds to the ESOP to either pay down, pay off or, in some cases, completely pay the purchase price.
The ESOP repays the company loan or the seller financing or both with the proceeds from the tax-deductible contributions made by the employer. This is often referred to as the company receiving a tax deduction for the repayment of the loan used to purchase its shares.
The ESOP may own 100 percent of the company or own company shares along with other continuing shareholders. The ESOP is represented by a trustee, who is a fiduciary, acting on behalf of the employees’ interest in the ESOP.
How much does the ESOP pay for the company’s shares?
The purchase price paid for the shares is based on an independent, third-party appraisal. The appraisal is conducted on behalf of the ESOP and based upon such valuation, the ESOP acquires the shares. The appraised value will reflect the market value of the shares sold.
How do I find out more about ESOPs?
An ESOP involves several parties like any other sales transaction. As discussed, the ESOP will need a trustee. The trustee will need legal and financial counsel, including an independent valuation provider. The company and the exiting shareholder require quality legal and financial advice as well.
Leveraged ESOPs require a bank or other lending institution. As with any other qualified plan, the company will need a plan administrator. In the end, the most important person to the company and its shareholders is an experienced ESOP facilitator.
Work with a professional that possesses the expertise to lead a company through the ESOP adoption process, as well as the share sale process. A strong firm can also provide qualified valuation analysts to assist with the valuation process. ●
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