If you’re thinking of selling your business, you owe it to yourself and your family to explore all viable opportunities to maximize the sale of your company. But what about your employees, many of whom have been with the company for years, have been instrumental to the company’s success, and are already running the company?
Throughout my banking career, I’ve seen many company buyout opportunities come across my desk. Many transpire successfully with seller financing, conventional bank financing, SBA loan financing, or a combination of these resources. But I’ve also seen buyout financing opportunities fail because the buyers’ access to capital was limited, especially if the potential buyers were the company’s employees.
ESOP TO THE RESCUE
When access to capital is limited, a leveraged ESOP (Employee Stock Ownership Plan) may be the answer to facilitating the sale of the business to employees because the leveraged ESOP relies on the company’s operating performance and cash flow to repay the borrowed funds.
By simple definition, an ESOP is an employee benefit plan which qualifies for certain tax-friendly advantages under the IRS code. The company sets up a trust for employees and:
- Contributes cash to buy company stock (regular ESOP)
- Has the ESOP borrow funds to purchase company stock (leveraged ESOP).
TAX ADVANTAGES FOR BUYERS AND SELLERS
- Company stock is allocated to each employee and employees are not taxed on stock allocations or earnings from the allocations until they receive ESOP distributions.
- The company makes periodic tax-deductible contributions/distributions to the ESOP and the ESOP uses these contributions/distributions to repay the loan.
- Company contributions to the ESOP are tax deductible (within certain limits). If the company is an S Corp, the ESOP’s earnings from the company's owners are exempt from IRS taxes.
AN ESOP HAS MANY USES
- Buy out the ownership of the current owner(s)
- Borrower funds at a potentially lower after-tax cost
- Employee benefit
AN ESOP HAS MANY BENEFITS
- Motivational: Employee ownership in the company
- Wealth Creation: Employee retirement vehicle
- Tax Benefits: Employee tax deferral on stock allocations and earnings
- Marketability: Ready market of company stock to shareholders
- Selling Owner: Tax deferral benefits to selling ownership
- S Corp Tax Benefits: ESOP earnings of an S Corp are not taxable
A WIN/WIN FOR BUYER AND SELLER
Whether you’re an owner considering selling your company, or employees who want to buy your company, a leveraged ESOP is an attractive alternative to finance the company purchase, transfer ownership to employees, and provide tax benefits to both seller and buyer. Discover what ESOP options are available for your business today.
This blog post is intended to provide general information only. It should not be considered legal, financial, or tax advice. The author of this blog post is not an attorney or a CPA. Always consult with an attorney or other trusted professional to determine what is best for your particular needs.
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