What is an ESOP?
Employee stock ownership plans (ESOPs) constitute an alternative option for selling a company by allowing employees to become beneficial owners of the stock in their company. Regulated by the Employee Retirement Income Security Act (ERISA) of 1974 – and encouraged by laws subsequently enacted by Congress – ESOPs were initially designed as a tool that could increase broad-based equity ownership for rank and file employees that would help them achieve financial security throughout their lives.
The legislation that created ESOPs also provided substantial tax benefits for selling shareholders to encourage owners of privately held companies to consider transitioning ownership to their employees.
An ESOP is an interesting cultural solution for a company that enables a selling shareholder to transition ownership of the business to a broad base of the employees, which, in turn, creates a very entrepreneurially focused culture amongst the ESOP owned companies.
A business owner typically has competing objectives when considering transition and liquidity options. Therefore, in addition to clarifying each objective in practical terms, the owner’s advisors must understand the relative levels of importance of those objectives to properly guide a client towards a successful transaction.Gregory Hogan
Why Do Businesses Consider ESOPs?
As of 2020, the National Center for Employee Ownership estimates there are roughly 6,600 ESOPs covering more than 14 million employees — evidence that, for some private business owners, ESOPs are a rewarding exit strategy. In addition to assuring the continuation of their business, owners leverage ESOPs for reasons ranging from their unique tax benefits to their ability to manage the business for years following the sale of the company.
Maintain Company Culture
Alternative 3rd Party Sale
What are the Benefits of an ESOP?
Tax Advantages for Both the Seller and the Company
If an ESOP is purchasing the shares of a C-Corp, selling shareholders can potentially defer, or even eliminate, the payment of capital gains tax on the sale of shares through investment in qualified replacement property. In addition, the company's contributions to the ESOP, including those required to repay the acquisition debt incurred in the transaction, are tax-deductible. Therefore, in many ESOP transactions, both principal and interest payments on transaction debt are tax-deductible to the company post-transaction.
Whereas third-party sales result in an immediate transfer of ownership and control, ESOP transactions allow shareholders to sell stock and transfer operational control over time. Because owners can withdraw gradually, they can remain active in the business years after selling all or most of the company, helping to preserve its culture and mentor the management team.
True to the tax law's intent, selling shareholders can provide their employees with significant retirement benefits. In addition, there are several other qualified or nonqualified retirement plans and compensation plans that can be put into place alongside ESOPs to further incentivize management.
"All ESOP transactions are different. Every shareholder has unique personal and professional goals, and we work together with them to help design an ESOP structure that will help them meet those goals and maximize returns."Lindsay Baublitz
Senior Vice President
Why is Proper Guidance Key?
ESOP transactions can be very complex. Each company and shareholder’s goals are unique and require an in-depth analysis to determine the most advantageous percentage of ESOP ownership (100%, majority, or minority), organizational structure (C-Corporation or S-Corporation), and financing options.
In a world where regulations are ever-changing, it is important to work with seasoned professionals who understand current regulations and guidance. SC&H Capital’s ESOP professionals understand the tax impacts on employee-owned businesses and Department of Labor ESOP regulations and best practices. In addition, SC&H Capital works with its clients to navigate financing alternatives to maximize liquidity.
ESOPs are a unique transaction type that requires partnering with knowledgeable and experienced advisors to guide the transaction to completion. While ESOPs are a viable option in the overall landscape of middle-market M&A, they are often overlooked and misunderstood and not the best fit for the majority of middle-market business owners, but, for some, it is ideal for their specific objectives.
Despite complexities referenced, DIY M&A—transactions executed without a lead sell-side financial advisor and with only limited assistance from legal and accounting counsel—still exist. As recently as a decade ago, you could go it alone and still have reasonable expectations of a successful transaction, but the odds today are prohibitively unfavorable. The middle market is far more global and fractured with ever-changing regulations for companies to walk the succession planning tightrope alone.
Why SC&H Capital?
Our dedicated ESOP experts assist plan sponsors with the formation, administration, and termination of their ESOPs. SC&H Capital professionals have a deep understanding of the unique challenges and opportunities that come with managing an ESOP because SC&H Capital itself is 100% employee-owned. We offer various professional services to ESOP plan sponsors, from advising on initial plan structuring to assisting with plan implementation to fulfilling compliance obligations. With the benefit of our seasoned experience, our clients meet goals and objectives and often realize gains beyond their expectations.
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