ESOP 101: EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS) Presented by Paige A. Ryan, ESOP Services, Inc. ESOP Services Inc. 2014 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages The process and team Characteristics of an ESOP
candidate 2 WHY ESOPS? Liquidity in part or whole Converting shares into cash at a fair market value, creating liquidity, in part or whole, enabling the business owner(s) to diversify their portfolios Perpetuation Selling shareholders stay involved, if desired Maximum tax efficiency Shareholders, Company, Employees Broadened ownership Employees incentivized to think like owners Strategic planning Achieve shareholder and corporate objectives 3
AN ESOP IS A TRANSITION ALTERNATIV E Answers the question, What are my alternatives for business perpetuation and creating liquidity? Sale to third party Merger Sale to management Corporate stock redemption Initial public offering
Gift or other transfer to heirs Wind-up business and liquidate Leveraged recapitalization Sale to Employee Stock Ownership Trust (potentially tax deferred with tax-free dollars) 4 OWNERSHIP 100% TRANSFER PRIOR TO SALE Company Company POST SALE Company Company Shareholder 1 ESOP Shareholder 2 Participant Participant
Shareholder 3 Participant Participant Participant Participant Participant Participant Employee Stock Ownership Plan Eligible employees become ESOP participants 5 Post Transaction Corporate Governance For a majority ESOP Nomination Committee Nominates Board of Directors for Trustee to Vote Nomination Committee
Board appoints Board appoints Audit Committee Board of Directors ESOP Committee Board appoints/removes Trustee Trustee(s) Manages Day to Day Operations of the ESOP Compensation Committee Company
Corporate Governance Committee ESOP Sponsor * Trustee elects Directors from nominating committees slate 6 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages
The process and team Characteristics of an ESOP candidate 7 AN ESOP IS A RETIREMENT PLAN Qualified, defined contribution, employee benefit plan (ERISA) The plan is regulated by the government (IRS and DOL) Invests primarily in the stock of the sponsoring company Qualified in that sponsoring company, selling shareholders, and employee participants may receive various tax benefits The US government has given the company tax breaks for setting up the ESOP
8 Plan Design ESTATE ESTATE PLANNIN PLANNIN GG The ESOP Plan governs SHAREHOLDER SHAREHOLDER LIQUIDITY LIQUIDITY LONG LONG TERM TERM STRATEGIC STRATEGIC PLANS PLANS
SELLER SELLER AND AND FAMILY FAMILY WEALTH WEALTH CAPITALIZATI CAPITALIZATI ON ON Eligibility THE ESOP PLAN Participation Vesting Allocations / Forfeitures
VALUATION VALUATION Distribution Policy Pass-Through Voting Repurchase Obligation EMPLOYEE EMPLOYEE OWNERSHI OWNERSHI PP CULTURE CULTURE CASH CASH FLOW FLOW EMPLOYEE EMPLOYEE BENEFITS BENEFITS REPURCHASE
REPURCHASE OBLIGATION OBLIGATION 9 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages The process and team Characteristics of an ESOP candidate 10
HISTORY OF ESOPS www.esopinfo.org www.esopinfo.org ESOP Companies More productive More profitable Higher survival rates esopassociation.org nceo.org esopinfo.org 14 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages
The process and team Characteristics of an ESOP candidate 15 TRANSACTION DESIGN ALTERNATIVES Non-leveraged Progressive Redemption and sale Leveraged Combination 16
Company NON LEVERAGED Stock Shareholder(s) ed at loc Al ESOP Accounts a Sh ares s re Sh
ated Alloc Company sets up an ESOP Trust Company makes annual tax deductible contributions in cash or stock to the ESOP trust Cash is used to buy stock from current shareholders Shares are allocated to the accounts of eligible employees within the ESOP, typically based on salary ESOP holds stock for participants and annually notifies them of how much stock is in their account and the value of the stock in their account Employees collect stock or cash, according to a vesting schedule, when they retire or otherwise leave the company 17 Former Participants
LEVERAGED ESOPS FINANCING ALTERNATIVES The ESOP receives a loan to purchase stock from current shareholders These stock is held in trust and released into employee accounts at a rate corresponding to debt amortization ESOPs typically acquire a block of stock with leverage (debt) funded by one or a combination of: Bank(s) Excess company cash Private equity group (PEG) Selling shareholder(s) Management investment (rare) Broad-based employee investment (rare) Combination (typical) 18 Company
100% LEVERAGED ESOP WITH SELLER DEBT (3) Contribution (1) ESOP buys stock from existing shareholders with a note (2) Shares are held in Suspense Account (3) Company makes annual tax-deductible contributions to ESOP to repay seller and bank debt (4) Shares are released from suspense account and allocated each year as ESOP repays sellers with contributions (5) Employees receive stock or cash when they retire or leave
(vesting applies) (1) ESOP buys Stock with Note (2) Shares to Suspense Suspense Account ESOP Accounts (4) Allocated Shares Stock Loan Payments Shareholder(s) (5) Stock or Cash 19
100% LEVERAGED ESOP (BANK AND SELLER DEBT) Company $10M VALUE $5M BANK DEBT $5M SELLER NOTES (1) $5M Bank Loan to Company (7) Periodic Payment ($500k) (1) Bank lends $5M to company (2) $5M Co. ent m y a KP 0 0 $5 (7)
(7) $1M Payment (4) Shares to Suspense (5) $1M Contribution Loan to ESOP (2) Company lends $5M to ESOP (3) ESOP buys stock from existing shareholders (4) Shares are held in suspense account (5) Company makes annual taxdeductible contributions to ESOP to repay seller and bank debt Suspense Account
ESOP Accounts Allocated Shares (6) Shares are released from suspense account and allocated each year as ESOP repays company loan (7) The ESOP then repays company, who then repays the bank and sellers (3) ESOP buys stock with $5M cash from bank and $5M note (which is modified with company post closing) (8) Employees receive stock or cash when they retire or leave (vesting applies) Shareholders (8) Stock or
Cash 20 HOW IS STOCK PRICE DETERMINED? BY LAW THE ESOP MAY NOT PAY MORE THAN FAIR MARKET VALUE AS DETERMINED BY AN INDEPENDENT VALUATION FIRM AND TRUSTEE Companys stock price will be determined annually by the ESOP Trustee based on an independent valuation firms determination of fair market value ESOP Trustee Expertise in ESOP trustee services Appointed to act on behalf of ESOP participants
Independent Valuation Firm Independent and experienced in valuation Utilize expertise, experience, industry standards, and guidelines provided by IRS 21 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages The process and team Characteristics of an ESOP candidate
22 TAX ADVANTAGE S Tax-deductible principal repayment [IRC 404(a)(9)] Tax-free S corporation income [IRC 409(p) and 512(a)] Tax-deferred sale - C corporation stock [IRC 1042] Tax-deductible dividends C corporation [IRC 404(k)] Contributions may be reimbursable under federal government cost-plus contracts ESOPs are frequently in addition to a 401(k) plan 23 ADVANTAGES
Company Substantial tax savings Increased cash flow Pre-tax dollars repay debt Tax-free income, S Corp ESOP stockholder not subject to federal and most states mirror Stockholders Liquidity in part or whole IRC 1042 tax-free rollover Selling shareholders can remain involved (if desired) Employees Share in equity growth Research shows ESOP companies more likely to have other retirement-oriented benefit plans Proven motivator Retains key employees 24 DISADVANTAG ES Requires debt to purchase larger blocks of
stock Seller can finance Bank and bonding approval must be considered Repurchase obligation Planning for funding options important The tax favors and employee benefits can be spectacular Compliance with regulations: IRS, DOL, ERISA Complexity Experienced advisors essential 25 PERPETUATION PLANNING C CORPORATION IRC 1042 TAX-FREE ROLLOVER Seller must have owned stock for at least three years prior to sale: Seller cannot have acquired the stock in a compensatory stock option plan or any other section 83 transaction, nor from a qualified retirement plan
Seller, certain related individuals, and greater-than-25% owners generally cannot participate in ESOP allocations 10% excise tax applies if ESOP disposes of stock within three years, except for normal benefit distribution Above rules do not apply if seller does not elect the tax-free rollover 26 PERPETUATION PLANNING C CORPORATION IRC 1042 TAX-FREE ROLLOVER Seller must have owned stock for at least three years prior to sale: Seller cannot have acquired the stock in a compensatory stock option plan or any other section 83 transaction, nor from a qualified retirement plan Seller, certain related individuals, and greater-than-25% owners generally cannot participate in ESOP allocations 10% excise tax applies if ESOP disposes of stock within three years, except for normal benefit distribution Above rules do not apply if seller does not elect the tax-free rollover 27
TAX STATUS CONVERSION C to S or S to C IRC 1042 tax-free rollover as C Corporation transaction, then convert to S Corporation S Corporation convert to C for tax-free Rollover five-year wait to convert to S 100% shareholder approval for S Corporation election 28 AGENDA Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages
The process and team Characteristics of an ESOP candidate 29 THE PROCESS Preliminary Preliminary Analysis Analysis Phase Phase II Decision Decision Package Package Phase II Implementation Implementation Phase IIIIII Ongoing
Ongoing No cost Confidential 30,000 foot view Valuation estimate Feasibility study, creating a decision package Plan and trust, and transaction documents Financing Repurchase obligation planning/funding Independent transaction valuation Employee communications Repurchase obligation Annual administration and valuation 30 ESOP TEAM Trusted advisors ESOP consultant Prepares feasibility study, the decision package, to ascertain viability and quarterbacks
implementation Corporate counsel and CPA, other advisor(s) Supporting and advising as needed Third party plan administrator Handles annual record keeping and compliance testing Independent appraiser Determines fair-market value Trustee(s) Acts on behalf of the ESOP and purchases stock ESOP counsel Drafts plan, trust and transaction documents Advises trustee(s) and other fiduciaries 31 AGENDA
Why ESOPs? What is an ESOP? ESOP history and facts ESOP mechanics Advantages and disadvantages The process and team Characteristics of an ESOP candidate 32 IDEAL CANDIDATE
C or S- corporation, LLCs can convert History of good cash flows Stock is privately held Shareholder interest in liquidity/diversification Sufficient payroll Debt capacity Shareholder interest in maintaining legacy of business and employee continuity Solid successor management team with interest in stock 33 IS AN ESOP RIGHT FOR YOU, AND YOUR COMPANY? 34 THE ANSWER: IT DEPENDS On shareholder goals and objectives Estate planning, personal financial needs, time table, control Businesss Strategic Plan
Projected growth, successor management, cash flow, employee benefits levels, ownership culture Current economic considerations Valuation, transaction financing, tax implications, current legislative environment 35 NEXT STEPS Learn more www.esopservices.com References Selected upon request Partial list at www.esopservices.com/reference.html Preliminary Analysis Call or email with questions! 36
ESOP Services, Inc. www.esopservices.com Founded in 1984, ESOP Services, Inc. responds to the needs of business owners to understand and analyze the ESOPs impact on the company, shareholders, and employees, focusing on the financial aspects of cash flow, tax savings, shareholder liquidity, and employee benefits. We specialize in all aspects of Employee Stock Ownership Plans for both private and public companies throughout the United States and internationally. Our unique approach emphasizes the financial aspects of ESOPs, while coordinating the many diverse elements necessary to successfully establish an ESOP. Paige Ryan San Diego, CA 92142 Phone: 858.292.4819 [email protected] Ron Gilbert Scottsville, VA 24590 Phone: 434.286.3130 [email protected] 37
