In these times of tight credit and an economy that continues to face challenges, many business owners are frustrated by their inability to sell their company.
In the current market, lenders and private equity funds are not only requiring a greater amount of equity from buyers, but also requiring sellers to 'hold paper' and to take more of the purchase price as an earn-out. Given the increased risk of value possibly not being paid to the seller, sellers may do well to consider an ESOP as an exit strategy.
An ESOP (or Employee Stock Ownership Plan) enables the selling shareholder of a company to transfer ownership with significant tax benefits to inure not only the seller, but also the buyer (i.e., the ESOP).
An ESOP is a qualified plan to acquire an operating company's stock. In certain circumstances, the seller's gain from the sale of stock to an ESOP can be deferred for many years, and through proper planning and dependant on estate tax rules, the gain would never be recognized.
These tax benefits certainly need to be considered in determining the net cash when evaluating transaction scenarios. Although at first blush a traditional transaction may seem better, based on the deal structure and tax consequences the ESOP may yield more net cash to the seller.
ESOPs acquire the seller's stock through either borrowing from a bank or through the seller exchanging his or her stock for a note. Since many traditional transactions are requiring sellers to hold notes, the ESOP is viewed as a similar risk to the seller.
To determine whether an ESOP may be the vehicle by which to sell your company, you must first have an understanding of the likely fair market value of the company, the likely participants and their qualified compensation (which is used to evaluate the debt-paying capacity of the ESOP) and the likely net cash to the selling shareholder.
A significant benefit to an ESOP company (a company that is 100 percent owned by an ESOP) is that under current income tax law, if structured appropriately, the company is not subject to federal or state income taxes.
ESOPs are a great vehicle to consider when evaluating an exit plan. Through proper planning, one can have a favorable transaction, as well as a legacy for the continuing employees and management of the company.
Mark Stepka, CPA, CVA can be reached at (760) 448-8193.