ESOPs - Employee Stock Option Plans

What is an ESOP?

An ESOP is a qualified retirement plan much like a profit sharing plan. The company makes contributions on behalf of the employees. The contributions are allocated to the employees accounts according to compensation. Then the contributions are invested and grow tax-free until the employee terminates or retires. Upon termination or retirement, the employee receives his or her vested interest in the plan.

But an ESOP is also much more than a retirement plan. An ESOP is designed to be invested primarily in employer securities. Once invested in employer securities, the ESOP becomes part of the corporation's capital structure. The ESOP also offers unique tax advantages that make it an effective tool for many business transactions.

Why do I need an ESOP?

An ESOP offers the following advantages to a company or farm corporation:

1. Improved employee and family morale and efficiency
2. Potential reduced interest costs
3. Potential reduced income taxes
4. New market for company stocks
5. Faster reduction of debts
6. Ability to expand more rapidly

ESOPs for S Corporations

As of January 1, 1998, employee stock ownership plans ("ESOPs") are eligible to be S corporation shareholders, and ESOPs do not have to pay tax on their share of the S corporation's earnings. Existing S corporations can now adopt ESOPs and take advantage of the benefits of employee ownership. In addition, C corporations with existing ESOPs or considering adopting ESOPs now have the option to elect S corporation status as part of their overall tax planning.

Adopting an ESOP for the S Corporation

The key benefit in adopting an ESOP for an S corporation is the ESOP does not have to pay tax on its share of the S corporation earnings. Instead, the single layer of tax is applied to the ESOP participants when they take a distribution of their accounts.

These tax savings make ESOPs an outstanding tool for S corporations in one of three situations:

	A current business owner sells stock to an ESOP as a business transition strategy;
	A current business owner sells stock to an ESOP to obtain liquidity for other needs; or
	A business uses an ESOP to acquire funds to an acquisition or growth strategy in a tax advantaged manner.

Business Transition Strategy

Owners of closely-held businesses often find themselves at the end of their career facing the decision of planning a succession strategy. The options may include going public, gifts to family members, selling to a competitor or selling to employees and management. Often the most attractive option is selling to employees and management. However, on their own accord, management generally does not have the capital to purchase the business. An ESOP provides the capital vehicle for management and the employees.

An ESOP can borrow money and use it to buy some or all of the owner's stock. Because the ESOP pays no tax on its share of corporate earnings, it can then use the tax savings to pay for the shares. This will enhance the corporation's cash flow and the value of the business. The employees and other remaining shareholders, including the selling shareholder if he retains an interest, will all benefit from the tax savings and increased cash flow opportunities.

The key to evaluating an ESOP strategy versus alternative strategies is to evaluate each thoroughly. The following is an example of some of the considerations.

Liquidity for the Shareholder

An ESOP can also be a great tool to provide an owner of a closely-held business with liquidity. An owner can use an ESOP to obtain financing to diversify investments or use some of the value of the company for personal uses such as a vacation home.

An ESOP can borrow money and use it to buy treasury stock to get extra cash into the company. Then, the owner can take a distribution of his or her basis in his or her stock without recognizing any tax.

The ESOP will not pay any tax on its share of the S corporation earnings and can use the tax savings to repay the loan. Similar to the situation above, the tax savings may help repay the loan, thus improving the corporation's cash flow.

Finance Corporate Growth or Acquisition

Rather than stripping the cash out of the company, many owners are using an ESOP to finance growth and expansion. In many cases, an owner can sell 1O% or more of the company to the ESOP and use the cash flow benefit to finance growth. In most cases, the value of the portion of the business retained by the owner will be worth more than if the owner did not sell any stock to the ESOP.

Equity's approach is unique. We combine the tax, accounting and benefit knowledge with the experience of many ESOP transactions to determine the design and strategy that works best for your corporation.

Leveraged ESOPs Can Provide Advantages to Everyone

The benefits of an ESOP accrue to everyone including the company, its employees and its shareholders. Companies benefit from ESOPs, not only from their tax advantages, but also from their flexibility in meeting many corporate planning needs.

Shareholders benefit from an ESOP because it creates a market for their stock, and tax laws allow for the deferral of capital gains of sales of stock to an ESOP. Continuing shareholders also benefit from a more profitable company.

Employees benefit because the ESOP makes them beneficial owners of that part of the company owned by the ESOP.

Advantages for the Company

	Deductibility of principal on loan repayments
	Possible lower interest rates on loans
	Increased productivity and motivation of employee/owners
	Financial solution for business succession
	Increased cash flow and working capital
	Attractive inducement to attract and retain employees, especially key employees

Advantages for Stockholders

	A ready market is available for the stock
	Employee/owners are concerned employees
	Enhances the stock price by strengthening the company
	Possible tax free rollover or deferral of long-term gains taxes on sale of stock to an ESOP

Advantages for Employees

	Employees share in the company's capital growth
	Stock in the company resulting from company contributions to the ESOP is usually received in addition to wages
	An ESOP can save jobs
	Enhances job satisfaction due to ownership incentive

Your Corporation Can Benefit

By implementing an ESOP, your corporation can create an employee/owner work force which has the same objectives as the shareholder. All are motivated to build a viable, growing and profitable company and derive greater work satisfaction. To the extent that the employees/owners are successful, they share in the capital appreciation of their ESOP account.

If your corporation is considering acquisitions, capital expenditure programs, and refinancing existing debt, you may find that an ESOP is the most effective corporate finance alternative.

How to Find Out if an ESOP Would Work For Your Corporation

ESOPs are important employee benefits, estate planning, and corporate finance tools. However, the ability of an ESOP to meet the objectives of your stockholders, management, and employees must be carefully examined before you make the required long-term commitment to such a plan.

Equity Financial Resources, Inc. is able to assist you in evaluating whether or not an ESOP is an appropriate alternative for meeting specific goals and objectives of the various parties. If an ESOP is not appropriate, we will tell you.

Feasibility Study

In order to determine whether an ESOP would work for your corporation we will prepare an individualized feasibility study to help identify your objectives and measure the ability of an ESOP to meet these objectives. Equity Financial Resources, Inc. will assist you in:

	Analyzing the various goals and objectives of the corporation, its shareholders, and employees
	Evaluating the financial feasibility for the cooperative
	Determining whether an ESOP should be established
	Designing the many details constituting an ESOP
	Developing of ESOP stock purchase transactions
	Communicating with employees regarding adoption of an ESOP
	Coordinating lender funding, if the ESOP is leveraged
	Planning for ESOP transactions
	Addressing funding of future repurchase liabilities

This process usually involves meeting with you and other key shareholders, your advisors and other interested parties to determine your needs and special circumstances. After analyzing your situation, we will recommend a course of action to accomplish your goals.

Equity Financial Resources, Inc. is able to advise you on all aspects of ESOP planning, implementation and transactions. We associate with ESOP professionals who specialize in ESOPs.

Our commitment to the client does not end after the ESOP has been created and implemented. We continue to advise our clients in administering the ESOP or utilizing the ESOP in further transactions. Our professional associates are constantly monitoring legislative changes in the ESOP and are able to advise our clients of any changes that may affect their plans. If needed, we can then amend our client's plans to comply with any new requirements. To learn more about ESOPs and how they might suit your corporation's needs, e-mail us or call.

The information provided was furnished from resources by Tim Cleary Esq. and Equity Financial Resources, Inc.

Business Planning | Financial Management | Project Management | Agri-Management Services
Financial Planning | Corporate Information | Testimonials | Contact Us | Home