Larry Kaplan, Ryan Barradas 2017-10-03 02:03:48
HARDLY — THEY ARE TAX-FREE STRATEGIES WORTH CONSIDERING For specialty tool and fastener distributors in search of liquidity, succession planning, or options for monetizing their business, selling the company to your employees may be an alternative worth considering. For most business owners, the majority of their net worth is tied up in their business and liquidating ownership is not easy and often involves a significant tax liability. The process of selling to a competitor or private equity firm is challenging, involves sharing sensitive information about the business to a party who may not end up purchasing your company. If the sale does go through, layoffs are likely and the company’s independence is lost. A unique alternative most people are unaware of is the ability for an owner to sell a business to the company’s employees through an Employee Stock Ownership Plan (ESOP). Selling to an ESOP is a tax-advantaged sale to a built-in buyer, an employee retirement trust, and there are numerous significant benefits to owners who take this sale approach. If the owner of a business tried to sell a minority stake to a third party, it’s likely that the buyer would command a premium for taking a small non-controlling stake. One notable benefit of an ESOP sale is the flexibility that an ESOP affords owners who only wish to sell a small piece of the business. An ESOP will still pay fair-market-value for stock in a company and gives owners the flexibility of selling incrementally over time. For owners looking to ease out of a business, this can be a huge draw. ESOPs also provide significant financial benefits. Depending on how the sale is structured, an ESOP can allow a selling owner to defer or avoid paying capital gains taxes on the proceeds. In some states, this represents 30 percent or more of the sale amount that the owner would otherwise pay to taxes. Further, a company that is owned 100 percent by an ESOP can become a completely tax-free business. In most cases, even when the business is operating free of state and federal taxes, the selling owner can continue to enjoy an upside in future business growth. Because ESOPs have little effect on business operations, owners tend to maintain their leadership positions and continue to operate the company tax-free even after selling to an ESOP. Employees also stand to benefit greatly when a business owner sells to an ESOP. Over time, as the ESOP pays for shares purchased from the owner, stock gets allocated to employee retirement accounts inside the ESOP. Stock is allocated to employees based on wages (i.e. higher-earning employees are allocated more stock) and most ESOPs use a vesting schedule designed to create a long-term incentive for employees. It is important to note that employees earn this stock by continued service for the company, but they never have to put any of their own money into their ESOP account like they would in other retirement plans. Upon retirement age (or other certain qualifying life events such as death or disability), employees can cash out their ESOP accounts and sell stock allocated to them back to the company. There are costs involved in implementing Employee Stock Ownership Plans and annual administrative expenses required to maintain them. ESOPs are not for everyone, but if the owner of a profitable and steadily-growing business is interested in exploring succession planning strategies or wanting to monetize all or a portion of their company — it is worth exploring the ESOP strategy as one alternative. Who should consider an ESOP? Owners considering selling all or part of their business in a tax-efficient manner Owners interested in keeping the business independent/ not interested in selling to a competitor A business owner interested in easing out over time Profitable businesses with steady or flat growth Business paying substantial income taxes Common ESOP Benefits Selling owner can defer/avoid capital gains taxes on proceeds from the sale Increase the company’s free cash flow — the company can operate entirely free from federal and state taxes Company remains independent after the sale Business owner continues to be involved in day-to-day operations Employees’ jobs remain secure and no risk of losing their job due to an acquisition Employees gain a meaningful retirement benefit as a result of the ESOP Who should not consider an ESOP? Companies that are growing but not yet profitable Businesses with fewer than 10 full-time W2 employees A business projecting decline in performance WealthPoint and CSG Partners are available to assist STAFDA members in evaluating various succession planning strategies, including how an ESOP can make sense for your business and key stakeholders. Larry Kaplan is the founder and managing partner of CSG Partners in New York, New York. CSG Partners is a leading middle market investment banking boutique with the largest ESOP advisory practice in the United States. Ryan Barradas is founder and managing partner of WealthPoint, LLC in Phoenix. WealthPoint focuses on succession, exit and wealth transfer planning for entrepreneurial family groups and is STAFDA’s succession planning consulting firm. *This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, tax advisor or plan provider.
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