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Get the Most out of an ESOP

Posted by: Today's Tip Contributor on January 27, 2011

The Great Recession ended the golden years for selling a privately held business. This is devastating to many baby boomers who planned on the sale of their businesses to fund their retirement. If you are one of these business owners, you should consider a sale to an employee stock ownership plan. An ESOP can provide liquidity and—by extension—a transition plan for exiting your company. There are several reasons ESOPs are a suitable succession strategy for businesses, and pending changes in the tax code could make them even more advantageous.

1. In 2011, the capital gains tax will increase to 20 percent. In the meantime, several states have raised taxes on income (and by extension, capital gains). A business owner can defer capital gains taxes on the sale of equity to an ESOP. If an owner sells more than 30 percent of the company’s common stock and reinvests the proceeds in a domestic operating company’s stock or bonds, he or she will not pay any capital gains tax until the replacement property is sold. If the owner dies still holding the replacement property, the heirs receive a step-up in basis, permanently extinguishing any capital gains tax from the sale.

2. Research shows ESOP companies perform better than non-ESOP companies. In 2006, the ESOP Assn. stated that 68 percent of ESOP companies reported "improved overall employee productivity" as a result of the ESOP. This makes sense, because the retirement benefits of an ESOP company employee are tied directly to the success of the company.

3. An ESOP affords the owner a choice to sell all or part of the company. By selling a part of the company to an ESOP, an owner can diversify his or her investments while still controlling and participating in the growth of the company.

4. If a company wants to expand, an ESOP is a perfect vehicle to borrow money to invest in the future. Contributions to an ESOP to pay down debt principal are tax deductible, whereas traditional loan principal repayments are not. This benefit results in greater cash flow and, in turn, a greater willingness on the part of lenders to lend at favorable rates.

Whether you want to sell your company, diversify your investments, incentivize and reward loyal employees, or expand your business, an ESOP may be just what the doctor ordered. For owners of privately held companies, an ESOP can be tailored to your needs and provide the best of all worlds.

Lance Hall
FMV Opinions

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