Esop Stock Acquisitions: An Introduction
As your company contemplates the future, you can consider several options during the succession planning process: continued private ownership by a person or persons, sale to an insider, sale to an outside investor, or sale to company employees. through the development of employee actions. ownership plan (“ESOP”).
The purpose of this document is to explain some of the stock transfer options from current owners to employees through an ESOP. The various methods of structuring a stock transfer discussed here are:
• Leveraged sale;
• Seller financed sale; and
• Annual Installment Sale/ESOP Purchase.
The examples contained in this document assume that (1) an ESOP will be established during the current year; (2) that your Company has a 401(k) plan that will remain in effect; and (3) the ESOP trustee shall be a group of employees approved by the Company’s Board of Directors.
When reviewing these options, keep in mind that they do not have to be mutually exclusive; You can combine one or more of the ESOP options in your ownership transition structure.
LEVERAGED SELL:
This ESOP share purchase method requires the Company to borrow funds from a bank to facilitate the ESOP share purchase transaction (assuming the Company does not have the necessary cash reserves available to self-finance the transaction). The Company, in turn, would loan the funds to the newly formed ESOP. The ESOP would use 100% of the funds it borrowed from the Company to purchase a block of shares from Shareholders. A leveraged sale requires that the block of shares purchased by the ESOP be valued as of the single date it is purchased.
Allocation of Shares in a Leveraged ESOP: In the case of a Leveraged ESOP, the shares are considered unallocated and are held in a suspense account until the Trustee makes loan payments to the Company. In this example, the loan is repaid over a 10-year period, so 1/10 of the total shares are “allocated” to participant accounts each year.
SELLER FINANCED SALE
This method of acquiring ESOP shares requires the Selling Shareholders to act as a financier of the ESOP, rather than a bank (or using the Company’s cash reserves). Under this scenario, each Selling Shareholder would receive one IOU (collectively, the “ESOP Notes”) from the ESOP in exchange for shares. The Company would normally guarantee the ESOP payment of the ESOP Bonds, and the Selling Shareholders would normally receive installed sales treatment for payments due under the ESOP Bonds.
This income tax treatment provides Selling Shareholders with the ability to recognize capital gains as payments are received each year during the term of the ESOP Bonds, rather than realizing the full amount of capital gains received. of the ESOP as of the date of the sale of shares. to the ESOP.
Seller financing can be, and often is, combined with bank leverage and/or an annual installment sale to provide selling Shareholders with an initial cash payment at closing of a seller-financed ESOP share purchase. A seller-financed sale requires that the block of shares purchased by the ESOP be valued as of the single date it is purchased.
Stock Allocations in a Seller-Funded ESOP: In the case of a Seller-Funded ESOP, the allocation of shares to eligible employee accounts is done in the same manner as in a leveraged ESOP.
ANNUAL SALE IN INSTALLMENTS / ESOP PURCHASE
This method of purchasing shares ESOP funds the purchase of shares annually based on the cash that ESOP has available to purchase shares each year. The Company’s annual cash contributions to the ESOP could be the annual source of ESOP cash flow for stock purchases. To the extent possible, S Corp income distribution amounts may also be used to finance stock purchases. This method of acquiring shares by an ESOP is less secure than the methods discussed above (and can be combined with either method, cash flow permitting) because (I) the Trustees must determine each year how many shares can be afforded buy from prospective Selling Shareholders; (ii) the price of the shares must be fixed each year from the date of each purchase of ESOP shares; and (iii) the Selling Shareholders may be required by written agreement to offer the Trustee the opportunity to purchase a specified number of shares or a percentage of their share holdings on or about a specified date, but the Trustee may not be required to purchase stock in advance. This method provides the Selling Shareholders with a possible fluctuation (+/-) in the sale price of the shares due to the obligations of the Trustee to pay the Selling Shareholders the fair market value of the shares as of the date of each ESOP purchase. . The valuation of the Selling Shareholders’ shares that are offered for sale to the ESOP under this method is a key element of planning because the ESOP may be acquiring a controlling interest in the Company over time and the Selling Shareholders seek to be compensated. for its shares at a majority price. interest value at the start of your sale of shares to the ESOP.
Stock Allocation in an Annual Installment Sale ESOP: In the case of an Annual Installment Sale ESOP, the ESOP purchases shares as cash becomes available. Therefore, the number of shares purchased each year may vary. The Selling Shareholders continue to own the shares until they are purchased by the ESOP. This arrangement is more flexible than a traditional leveraged or seller-financed arrangement, but such flexibility increases the annual administrative costs of the ESOP, because each annual installment sale to the ESOP will require (1) that the Trustee receive an opinion from its financial advisor of that the transaction-stock meets certain ERISA standards, and (2) the preparation of separate legal documentation matches each of the actual ESOP stock purchases.
If you have questions about business succession planning, employee stock ownership plans, or other corporate matters, please feel free to contact Adam S. Tracy Esq at (888) 978-9901
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