ESOPs for Consulting Firms

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good morning welcome to the web seminar on ESOPs for consulting firms
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my name is john menke i’m the president of Menke & associates inc today’s seminar will be in a question
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and answer format i’ll ask a series of questions regarding how esops can be used by consulting
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firms to accomplish various goals and objectives and chuck bachmann will provide the answers based on his
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knowledge and experience in designing these stops for dozens of consulting firms chuck bachman is both an orisa lawyer
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and a certified public accountant and he’s been a member of our firm for over 10 years
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by way of background minking associates is the oldest firm in the country specializing in esops our firm was
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founded in 1974 and 2005 marks our 31st anniversary of designing and installing esops over
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the past 30 years we’ve created more than 2 000 e-stops more than any other firm in the country
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we also administer about 800 esops also more than any other firm in the country and we have six offices throughout the
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united states and we’ve installed esops in all 50 states let me begin by
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defining what an esop is and esop has many things to many people
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to the existing shareholders it’s a buyer of stock that simultaneously offers tax savings
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to the seller and an orderly succession plan for both majority and minority shareholders
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to the company the east off is a technique of corporate finance that enables a company to finance growth
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and expansion and or shareholder redemption with tax deductible dollars
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while simultaneously providing a highly effective employee incentive plan and to the employees an esop is a
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company funded retirement plan that offers them an incentive and a reward that is usually unmatched by any
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other type of retirement plan it’s important to note that an esop consists of both a plan and a trust
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and that the trust is the direct owner of company stock not the employees typically the company owners are
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designated as planned trustees employees will receive annual statements reflecting their account balance in the
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esop however they’re not entitled to company financial statements nor do they have voting rights except
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with respect to certain special issues therefore voting control does not have to change when an e-stop is implemented
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even when an e-stop owns the majority of the stock now i’d like to ask chuck the first question why is it that esops are
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popular with owners of privately held business well john over the past 31 years
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esops have been increasingly popular among privately held firms because they offer a number of tax and financial
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advantages that are not available under other alternatives the most frequent use for an esop for
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example is to create partial or total liquidity for existing shareholders
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esops are uniquely designed to accomplish this objective in the great majority of cases the
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primary purpose of the esop is to create an in-house market for existing shareholders the advantage that an esop
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brings to the table is that it enables the company to repurchase shares from existing shareholders
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using tax deductible contributions rather than after tax funds
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in the case of a regular c corporation congress provided a special tax incentive to encourage companies to use
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e-stops for shareholder liquidity in this special tax provision if the esop acquires 30
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or more of the stock of a privately held company the tax on the gain will be deferred
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provided that the selling shareholders reinvest proceeds in qualified replacement property
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in the case of s-corporations there is also an advantage of using an esop to create shareholder liquidity
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rather than utilizing a stock redemption the advantage of selling to an esop is that any amount of stocks sold to the
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esop will qualify for favorable capital gain rate which under the current tax code is only 15
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at the federal level in the case of a stock redemption the redemption has to be substantially
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disproportionate in order for the redemption to be taxed at capital gains rates rather than ordinary income tax rates
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qualifying a stock redemption as a disproportionate redemption is often difficult
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and in the case of a sole owner is in fact impossible to achieve and esop on the other hand is very
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flexible and not limited by the rules that apply to stock redemption the second reason why esops have been
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increasingly popular is that whether the company is a c corporation or an s corporation an esop can help a company
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to substantially eliminate the payment of federal and state income taxes on the earnings of
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the company we will discuss the techniques for doing this in more detail later in the session the third advantage
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of using an estop is that in most cases you can continue to control the company just as you do
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now unlike a sale or merger you can create shareholder liquidity for yourself
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and for other shareholders of the company yet still retain control even after selling the majority of
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outstanding stock to the esop the fourth advantage of using an esop is that monies that the esop borrows in
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order to buy out existing shareholders can be repaid entirely with tax deductible dollars
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that is to say the company will be able to deduct not only the loan interest as is done in the case of a stock
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redemption but also the loan principle this is unique to esau last but not
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least when properly implemented and communicated an esop can have a dramatic effect on increasing employee
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productivity this in turn can result in increased profitability and an increase in the overall valuation
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of the company as a result of the various tax and financial benefits that ethos have to
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offer there are now over 11 000 esops currently in existence and these esops cover over 10 million
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participants it is estimated that the total value of all esop assets
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now exceeds 500 billion now i’d like to talk about how esops can be used by
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owners of consulting firms chuck what are the common ownership problems that are faced by owners of
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consulting firms well john the common ownership problems that are faced by owners of consulting
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firms are in general the same problems that are faced by owners of all privately held firms
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namely lack of liquidity lack of diversification and the need for a succession plan
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fortunately the esop is one of the tools that can provide an answer to all three of these
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problems it can provide liquidity and diversification for existing owners and it can also provide for an orderly
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business succession strategy as a liquidity tool the esop offers a
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number of advantages the esop creates an in-house market whereby existing owners can sell their
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shares as and when they see fit unlike a sale or merger an esop allows the owners to sell part of their
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shares rather than having to sell the entire company thus the owners can sell their shares over a period of years
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rather than having to sell them all at once since the esop creates an in-house market
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no outside party is involved and there is a certainty of the outcome also the cost of arranging a sale to an
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esop is a fraction of the cost that would be incurred by selling to a third party
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as a tool for investment diversification the esop allows you to diversify whatever amount of stock you wish to
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liquidate and invest other investments such as cash fixed income securities or equities the mix of
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investment selections is entirely up to you as a tool of business succession the esop is probably
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the least stressful method of ownership transfer due to the fact that it does not involve an outside buyer
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with an esop there is certainty of outcome and there is less likelihood of employee layoffs and or changes in
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management in fact an esop purchase can be combined with management buyout so the management can
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acquire significant equity in the company the particular advantage that an esop offers is that it can provide for a
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gradual change of ownership to the employees in the meantime the existing owners still retain the right to sell the
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entire company at a later date and still retain the right to control the company in the meantime
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chuck it’s easy to see that restops offer a number of financial and tax advantages not offered by other alternatives
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but why is it that e-stops are especially popular with consulting firms i think that esops are especially
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popular with consulting firms because these firms are by definition service businesses where the success and profitability of
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the firm depends almost entirely on the productivity of the employees also the bulk of the employees and
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consulting firms are professional employees who expect over a period of some years
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to become partners in the business since most consulting firms are now structured as corporations rather than partnerships
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this means that they expect to be shareholders of the company after they’ve been with the firm for a number of years
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the disadvantage of operating as a corporation is that it is much more difficult to transfer shares of stock
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to a new employee’s shareholder than it is to assign a partnership interest to a new partner if for example
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the company simply issues newly issued stock to a new employee shareholder that employee shareholder will recognize
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ordinary income for a fair market value of the stock in addition issuing newly issued stock to a new
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employee does nothing to create liquidity for existing shareholders who may desire to retire or liquidate
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part or all of their shares another reason why esops are so popular with consulting firms
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is that as a general rule these types of firms prefer to be locally owned and operated
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unlike manufacturing and other types of firms it is more common for consulting firms to be acquired by their managers
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and employees than to be inquired by a competitor a public company or a financial buyer such
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as a buyout firm a third reason why consulting firms utilize esops
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is that the esop can be a very useful tool in helping a company attract and hire high quality employees again
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professional employees are much more inclined to accept a job offer from a company that provides the opportunity for stock
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ownership then from a company that provides no such opportunity lastly ethos are popular among
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consulting firms because these types of firms fully recognize that their professional associates
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are in fact their most valuable asset in the absence of an esop or similar type
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of program there is always a risk that the key employees will simply walk out the door and start a competing company for all
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the foregoing reasons i think esops are especially good fit for consulting firms in fact among our 2000 plus client base
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consulting firms are most frequent clients chuck given that east south far in
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general a good fit for consulting firms are there any situations where an esop is not a good
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fit for a consulting firm yes john there are a few situations where esop is not a good fit
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one situation would be where the firm is simply too small to have an esau as you know we’ve done esops for
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companies with as few as 10 employees and as many as 10 000 employees however
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it is usually not economical to install or maintain an esop if the company has fewer than 10
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employees in addition if the company is an s corporation and has 10 or fewer employees it can be
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difficult to pass the so-called anti-abuse provisions that are set forth in section 409 p
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of the internal revenue code if the company cannot comply with these provisions then they’ll have to either forego
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becoming an esop or convert to c corporation status the second situation where an esop is
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not a good fit is where the company is relatively new and not yet profitable in order for an esop to be most
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effective the company needs to be profitable in paying taxes these hops are generally used for four
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principal purposes first to create liquidity and diversification for sellers
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second to increase employee productivity third to increase company cash flow and force to provide
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for business diversification let’s start by discussing how esops are used to create liquidity and
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diversification for sellers chuck how are esops typically structured
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to create liquidity and diversification for owners of consulting firms pretty much the same way that they’re
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structured for other types of firms how the east of the structure depends upon the goals and objectives of the
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current shareholders esops can be extremely flexible in how they can be structured for shareholder
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liquidity purposes in general there are three basic ways an estop can be structured
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the first is what i call a pre-funded esau a pre-funded esop is one where the esop
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is established and the company makes contributions to the plan and cash which is accumulated to later be
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purchased from the shareholders many companies start out by using a pre-funded esop as a way to generate
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current tax deductions and as a way to accumulate cash in the plan where for one reason or another the
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current shareholders are not willing to start selling their shares under the current code provisions a
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company is allowed to make tax deductible contributions each year in any amount up to 25 percent
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of eligible payroll thus for example if the company’s eligible payroll is 1 million
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it could make a tax deductible contribution of up to 250 000 dollars per annum
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thus if the company contributed the maximum amount each year after a period of four years the plan
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would have an accumulated piggy bank of at least a million dollars in funds plus however
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much interest might be earned on those funds many times the company is already spending these funds in a 401k match
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or in profit-sharing contributions which do not have the flexibility to invest in company stock
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the second way an esop can be structured is the gradual esop a gradual esop is one where the company
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makes discretionary contributions each year up to the maximum deductible amount and
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uses these contributions to purchase shares from existing shareholders on a year-by-year basis the advantage of
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this approach is that it’s highly flexible the company has complete discretion as to how much it contributes to the
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plan each year the advantage to the selling shareholders is that they are only selling a small percentage of their
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stock from year to year however unlike a stock redemption each and every sale to the esop will
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qualify for favorable capital gains treatment in the case of a c corporation once the
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esop has acquired 30 or more of the outstanding stock then the sellers can also elect to defer
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indefinitely the taxation of their capital gains provided that certain conditions are met
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the third way that an esot can be structured is as a leveraged esop a leveraged esop structure is used where
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the shareholders want to cash out more quickly or in the case of a c corporation want
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to immediately qualify for the tax deferral of their capital gains taxes as mentioned earlier in order to qualify
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for the tax deferral the esap must acquire at least 30 percent of the outstanding shares
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unless the plan has been pre-funded the esup will usually have to be leveraged in order to have enough funds to
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purchase 30 percent of the outstanding stock and how is the plan leveraged does the plan borrow the money or does the
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company borrow the money good question let me explain this by giving a specific example
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let’s assume that we have a company with annual sales of 10 million dollars an eligible payroll of 1 million pre-tax
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profits of 600 000 and a fair market value of 3 million
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let’s further assume that the esop wants to purchase 30 percent of the outstanding stock for a price of 900 000. the way this
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works is that the bank lends 900 000 to the company and the company then lends 900 000 to
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the esop the esau then purchases 30 percent of the outstanding stock from the company’s
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shareholders for 900 000 in cash at the end of the year the
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company then makes tax-deductible cash contributions to the esop and amount up to 250 000 plus interest
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the esop then uses that contribution to repay interest and principal on the company
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loan the company then repays the bank loan assuming that the sellers qualify under
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the tax deferral provisions they will wind up saving anywhere from a hundred and thirty five thousand
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to a hundred and eighty thousand dollars in federal and state taxes depending upon state income tax rates
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of course these structures can be combined if useful and necessary case for for example combines the
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pre-funding and leveraging ideas of cases two and three in this slide for example you
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will note that the company pre-funded the esop for two years accumulating about four hundred thousand
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dollars in cash meanwhile the company grew from a fair market value of 3 million
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to 3.33 million at the end of the third year in order to reach the 30 percent
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threshold the esau needs to own 1 million of stock since 400 000 is already accumulated the
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required bank loan need only be six hundred thousand which is three hundred thousand dollars less than would
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have been required if no pre-funding had occurred therefore the required loan is reduced
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by 33 percent and the annual debt service is reduced by over eighty one thousand dollars a
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year similarly case five combines year by year purchases
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with tax deferral sale in year four as shown by this slide at the end of the
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first year the esop would purchase three percent at the end of the second year the esop would hold seven percent
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at the end of the third year it would own 12 percent each of these sales will be taxed at
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capital gains rates however the sale in year 4 would result in the esop owning 30 percent
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thus the seller would be able to elect tax-free rollover with respect to the stocks sold to the esop in year four
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case six illustrates how an esop can be structured to accomplish a one hundred percent esop buyout
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in most cases it is not possible to obtain financing to accomplish a one hundred percent esop buyout in one
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fell swoop accordingly a one hundred percent estop buyout is usually structured
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as a two stage buyout in the first stage for example the esop might be leveraged
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in an amount sufficient to buy fifty percent of the outstanding stock then after the loan is paid off the plan
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could be re-leveraged in year four to buy the remaining fifty percent chuck
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what if there’s more than just one shareholder of the company what if there is majority shareholder and one or more minority shareholders
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can the stop offer to buy out the majority shareholder without also making the same offer to minority
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shareholders in most cases the shareholders will readily agree among themselves
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as to whether the esop is to be used to purchase part or all of the stock of a majority stock
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of a shareholder or part or all of the stock of one or more of the minority shareholders
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or a combination of the two however if for some reason the shareholders cannot agree among themselves
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then it is typically the case that the esop will buy stock from all the shareholders on a pro rata basis you mentioned
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earlier that in the case of a c corporation there’s a special provision of the code that allows selling shareholders to
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receive their proceeds on a tax deferred or tax-free basis can you tell us a little more about how this works yes
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under section 1042 of the code if the esop acquires 30 or more of the stock of a privately held
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c corporation the capital gains on the amount of the gain will be deferred provided that the seller reinvest a like
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amount of money in qualified replacement property within 12 months from the date of sale
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this tax deferral will continue as long as the seller holds the qualified replacement property if the seller holds
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the property until its death then it will receive a step up in basis and capital gains tax will be completely
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avoided this type of transaction is typically referred to as a tax-free rollover qualified replacement
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property consists of stocks or bonds of american corporations the corporation may be big or little
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public or private but they must be american the seller cannot invest in a mutual fund
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or in a government security unless he’s willing to pay capital gains tax most sellers who elect the tax deferral
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wind up investing the proceeds in a diversified portfolio of corporate stocks and corporate bonds
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a seller can always sell part of his replacement securities later on to the extent that he does so however he
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will have to pay capital gains tax that was previously deferred as well as a gain on any subsequent
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appreciation chuck is there any way to avoid being locked in to these replacement
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securities and having to hold the same investment portfolio until death yes there is relatively simple way
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around this problem and that is to purchase long-term esop bonds and then margin out eighty percent to ninety
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percent of the proceeds for example assume that a seller receives nine hundred thousand dollars
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from the sale of the stock to the esop he could then purchase nine hundred thousand dollars worth of long-term
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esop bonds and then this purchase would satisfy the requirement that the seller must purchase
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qualified replacement securities the seller could then margin out say 720 000 of the proceeds and then invest
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these funds as he or she sees fit chuck you’ve mentioned that the tax free
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rollover provisions do not apply to the shareholders of s corporations are there any tax
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advantages that apply to s-corporations that do not apply to c-corporations
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yes as you know in the case of s-corporations all the earnings of the corporation are taxed at the shareholder
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level rather than at the corporate level as you also know that esop is a tax-exempt
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entity thus to the extent that the stock of an s-corporation is owned by an esop
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part of the corporation’s earnings will be exempt from income tax thus in the case of an s corporation
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that is a hundred percent owned by an esop none of the corporation’s earnings will be subject to income tax
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the esop share of the s corporation earnings is also exempt from the unrelated business income tax
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there are only two disadvantages to s-corporation esops the principal disadvantage is that there
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is no tax-free rollover available to sellers they must pay capital gains on the sale
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the second disadvantage is that the s corporation esops must cover a broadly based group of employees
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under this test if the disqualified persons own more than 50 percent of what is called
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quote deemed owned shares unquote then the e-stop shares of the earnings will be subject to the unrelated
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business income tax and the disqualified persons will be subject to certain excise taxes
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check in view the fact that in the case of s-corporation esops the tax benefits accrue more for the benefit
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of the company itself rather than for the benefit of the selling shareholders are esop transactions structured
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differently for s-corporations than for c-corporations basically all the same structures that
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are used by c corporations are also used by s-corporations as in the case of c-corporations with
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s-corporation esops some esops are structured as pre-funded ethos some are structured as gradually subs or
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the esop purchases shares year by year and some are structured as leveraged esops
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however because of the fact that the company will be 100 tax exempt if the esop is the sole
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shareholder we have seen more 100 percent esop buyouts of s corporations than we have in the case
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of c corporations also because of the difficulty in securing 100 bank financing for a buyout many of
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these transactions have been structured with 100 seller financing here is an example of
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how leveraged esops are typically structured for s-corporations in this example the owner julie is the
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sole shareholder and pays herself a salary of 200 000 a year
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there are 20 other employees that have total compensation of 800 000 so that julie’s compensation is 20
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of the total payroll the company has a value of 4 million dollars case seven shows how the transaction
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will be financed with seller financing in this case julie becomes the banker herself by taking back an installment
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note from the esoc julie will receive installment payments over the term of the note
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as she receives the principal she’ll have to pay capital gains tax on the portion of the principal payment
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that represents gain and she’ll pay ordinary income tax on the interest portion but the
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important thing to point out is that the esop now owns 100 of the company the company no
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longer has to pay any income taxes assuming a pre-tax profit of 800 000
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this would result in a tax savings of over 300 thousand that would otherwise be paid each and
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every year in taxes that same three hundred thousand can be used instead to pay a large portion of
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the installment payments that will be paid to julie each year on her installment note
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the next slide illustrates two points with respect to leverage dsops first it illustrates how the debt is
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repaid in the case of an s corporation the debt is repaid by having the company
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make tax-deductible contributions to the esop which the esop then uses to make note
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payments to julie in the case of an s corporation the debt can also be repaid by using s-corporation distributions
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that are paid to the esau and then used to make note payments to julie
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debt is repaid the same way in c corporations except that c corporations aren’t
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allowed to use s-corporation distributions to shareholders instead there’s a special code provision
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that allows for c-corporations to pay so-called quote deductible dividends unquote to the esop
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over and above tax-deductible contributions normally c-corporations don’t pay
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dividends because these dividends are not tax deductible in the case of an esop
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however if they’re used to repay esau debt the dividends will be tax deductible
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the second point of this slide is to illustrate how stock is allocated in the case of a leveraged esop in the
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case of a gradual esop obviously the stock is allocated on a year-by-year basis
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as when shares are purchased in the case of a leveraged esop the stock is allocated to participants
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as note payments are made thus if the esop purchases 100 of the outstanding stock
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all of the stock is initially held by the esop in a suspense account then each year as the company makes
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contributions to the plan and the contributions are used to make note payments to the seller
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or to the bank lender if the bank is involved a pro rata portion of the shares is released from the suspense
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account and allocated to the accounts of the participants the block of stock that is released from
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the suspense account each year has been allocated among the accounts of the participants in proportion to covered compensation
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the alternative for structuring a leveraged esop is to have a transaction financed with a bank loan rather than a
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seller node thus if julie wants to receive cash right away from her stock
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then external bank financing would be required in order to put 4 million dollars into julie’s pocket right away
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thus case 8 is the same as case 7 with the exception that a bank is now involved the concept however is exactly
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the same the esop owns 100 of the company therefore the company pays no taxes and
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the lender is being repaid with pre-tax dollars because the company is now tax-exempt
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from paying taxes whether the esop is bank financed or seller finance the results will be the
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same in either case first the company’s earnings will no longer be subject to income tax
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second julie will receive four million dollars and pay capital gains tax on her gain
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third since julie’s compensation constituted 20 percent of the total covered compensation julie
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will be allocated 20 of the stock within the esop and she will be able to cash out later
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when she leaves the company you should note that this benefit does not apply in the case of c corporations
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where the seller has sold stock to the esop and elected the tax-free rollover treatment in that case there’s a special rule that
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prohibits the selling shareholder and related parties from receiving any allocation of the stock
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that was sold in the tax-free rollover transaction fourth since the earnings of the company
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are no longer subject to income taxation the company no longer has to make distributions to the shareholders
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to enable them to pay their income taxes instead these funds can now be used to repay debt
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after the debt is repaid these funds can be accumulated in the company and used to make acquisitions or
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otherwise fund growth and expansion so far we’ve talked about esop’s being
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used to create liquidity and diversification for shareholders the second use of esop is to increase
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employee productivity sometimes the primary purpose for adopting an esop is to create a direct
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link between the employees productivity and their retirement benefits it’s simply common sense that people
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work best when they work for themselves as they say no one ever washes a rental car the concept of an esop
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is to have employees think and act like owners chuck the obvious question then arises
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do we restops in fact increased employee productivity yes numerous studies conducted over the last
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17 years have all concluded that esop’s increase in company performance for example one of
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the early studies found that employee absenteeism went down by 66 percent
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and employee turnover went down by 50 percent after implementing the esop more
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recently there were two harvard business review studies that found that sales growth in esau companies was
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significantly higher than comparable non-e-stop companies more importantly
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two independent studies won by northwestern universities calallen school of management
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and one by hewitt associates both found that esot companies had a higher return on assets
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and higher return on shareholders equity than comparable non-esop companies chuck what’s the impact of increased
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employee productivity on profitability and the overall value of the company
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is it relatively nominal or is it significant the impact can be quite significant this
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slide illustrates for example that a two percent increase in productivity can literally
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result in a fifty percent increase in profitability in this case we assume that a company
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had ten million in revenues and a pre-tax profit of four hundred thousand as indicated if the sales force can
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increase revenues by two percent but hold expenses constant the pre-tax
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profit increases by 50 percent another way that profitability can be
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increased by 50 percent would be if employees were able to reduce expenses by two percent
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while holding revenues constant of course the employees can both
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increase revenues by two percent and reduce expenses by two percent then the company would
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literally experience a 100 percent increase in profitability
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the third use of an esop is to increase corporate cash flows this can be accomplished by simply
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having the company contribute newly issued stock or treasury stock to the esop on a year by year basis
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the result is to reduce corporate taxes and increase cash flow while simultaneously providing
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retirement benefit for the company’s employees chuck what are the pros and cons of using an esop to increase
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company cash flow as you just mentioned that the principal advantage of using an
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esop to increase cash flow is that the company’s cash flow and net worth will be increased
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the potential disadvantage advantage is that issuing new shares of stock to the esop
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will create dilution to the original shareholders actually there is no dilution if the
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contribution to the esop is in lieu of cash bonuses or cash contributions
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that would be made in another form of retirement plan as illustrated by this slide for example
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if the company contributes three hundred thousand dollars worth of stock to esop in lieu of a three hundred thousand
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dollar 401k matching contribution or a three hundred thousand dollar profit sharing
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contribution the company has in effect received three hundred thousand dollars of cash
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in exchange for three hundred thousand dollars worth of stock if the company puts this money to good
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work the value of the company will increase for the benefit of all its shareholders if the company does not spend the money
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wisely then there will be dilution of the shareholder’s equity fourth use of an esop is to create a
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succession plan for the existing shareholders in my view an esop
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transaction is the least stressful and most efficient means for transferring ownership to the next generation for three primary reasons first it
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utilizes pre-tax cash flow rather than after tax cash flow second it’s usually done in stages
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and therefore involves less leverage and third it usually involves no change in management control at least at the
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outset in most cases there’s only a gradual change in management control over a long period of time chuck what is
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your view of an esop as a tool for business succession in the area of business succession and
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transition an esop is on its own is usually not the sole answer to one’s objective
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for example many owners wish to reward their key employees as well as certain family members in
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addition to the esop participants stock sales can be made directly to the key group of employees
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and stock grants can be made to family members in many if not most cases we recommend
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creating a special non-qualified management stock bonus plan that is created specifically for
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the key employees who’ll be responsible for the long-term growth and succession of the business
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chuck we’ve talked about the various advantages of an esop what are the disadvantages of an esop
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there are several potential disadvantages of an esop depending on the facts and circumstances
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however in most cases the alleged disadvantages are more perceived than real
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one potential disadvantage of a sale to the esop versus a sale to a third party is that any sale to an esop depends upon
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the ability of the company to obtain the necessary financing if the transaction is financed with a bank loan
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the company must have the ability to obtain the necessary bank loan based upon having sufficient cash flow
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to service the loan and sufficient assets to collateralize the loan if the company does not have sufficient
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collateral the seller may have to give a personal guarantee or may have to pledge a portion of the
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qualified replacement securities on the other hand a seller can always
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self-finance the sale in whole or in part if sufficient bank financing is not
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available another potential disadvantage of an esop sale
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is that the debt incurred to finance the transaction will reduce the company’s net worth this
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is no different than in the case of a stock redemption or a management buyout and in most cases has little or no
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impact on the company’s operations the only case where it does have an impact is in the case of construction
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companies that are required to obtain construction bonds if the company’s net worth is
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gradually diminished the company may have difficulty in obtaining necessary bonding
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in general shareholders of construction companies should sell gradually over a period of years
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in order to avoid any sudden reduction of net worth shareholder dilution is another
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potential esop disadvantage shareholder dilution comes about only if the esop is funded with newly issued
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shares of company stock since most esops are funded with cash which is used to purchase
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shares of existing stock rather than newly issued stock dilution seldom comes into play even if
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the esop is funded with newly issued shares the dilution is usually not significant
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as illustrated in this slide in fact if the cash flow savings are put
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to good use the dilution becomes an advantage rather than a disadvantage to the extent that it enables the
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shareholders to own a smaller piece of a bigger pie a common misperception
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is that a knee stop results in a loss of control this is not at all true in a case of an
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esop the board of directors appoints the controlling shareholder as the planned committee and trustee thus the controlling
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shareholder continues to vote the shares that he has sold to the plan as well as the shares he owns outside
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the plan the planned committee directs the voting of all esop shares on all ordinary
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issues such as the annual election of the board of directors thus there is never any loss of control
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the only exception is that participants in the plan are allowed to vote on certain quote
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special issues unquote the special issues that participants are allowed to vote on
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include only merger consolidation recapitalization liquidation or sales
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substantially all the corporate assets and even on these special issues the
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participants are only allowed to vote with respect to those shares that have actually been allocated to
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their accounts all unallocated shares are still voted by the trustee
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also participants do not vote any proposed sale of stock to a third party
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since this is a fiduciary decision not a decision that requires a shareholder vote
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it is important to note that an esop does not take away any of the other shareholder liquidity options the controlling shareholder
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can still sell his remaining non-esat shares to a third party and the plan committee can still elect
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to sell all the esop shares to a third party another misperception is that having an
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esop will require the company to disclose confidential financial information again
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this is not at all true the only disclosures that are required are that participants must be furnished
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with an annual benefit statement which discloses their total account balance their percentage vesting and the per
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share value of the stock having an esop is not expose the trustees to any greater degree of
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fiduciary liability than they would have as trustees of a pension or profit sharing plan
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in fact the fiduciary liability is somewhat less since the trustees of the esop are
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exempt from the normal requirements to earn a fair rate of return to diversify the investments and to
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provide investment liquidity yet another misperception is that having an
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esop creates quote repurchase liability and quote for the stock that is acquired by the
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esa the fact of the matter is all stock ultimately will need to be repurchased
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that’s why stock has value the difference is that in an e-stop the repurchase of such stock will be
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spread over the lives of all the plan participants and will be made with tax-deductible
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dollars whereas in the case of a stock redemption the repurchase will come due all at once
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at the death or retirement of the owner and will be made with after-tax dollars
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lastly it should be noted that selling to an ethop unlike a merger or sale to a third party
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is not an irreversible decision if you later change your mind the esop can be terminated
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and all the shares be distributed and repurchased in the alternative the esop can be
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frozen and the shares can be gradually repurchased as employees die or retire
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thanks chuck minkin associates is a specialist in employee stock ownership plan design
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installation administration and valuation minking associates has been designing esop since 1974
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and offers a full spectrum of esop services the design and installation services
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provided by minkin associates include preparation of the formal business appraisal of the company
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financial consulting regarding the transaction drafting of all legal documents
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irs approval of the planned documents preparation of the employee communications booklets
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conducting powerpoint presentations for the employees and assistance in setting up the
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accounting and administration systems required for the plan on an annual basis mintkin associates
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also provides the annual record-keeping services including the preparation of individual
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employee benefit statements an additional service that’s required annually is the update of the
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stock appraisal in order to report to the employees the value of their retirement plan as
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well as to establish that value should the esau buy a second or third block of stock
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it’s critical to use an esop firm that is a specialist in this area with an experienced firm fully stop
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services will be provided at less cost to the client and there will be fewer errors incurred in
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the process minikin associates has designed over 2000 esop since our inception in 1974 and we are the
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nation’s number one firm in esop activity men can associates is headquartered in
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san francisco california with offices in los angeles portland chicago atlanta and wilmington
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delaware our appraisers are located throughout the country as well
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but how do you know if your business is an appropriate candidate for an esop just take a few minutes to complete the
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confidential feasibility questionnaire form on our website at www.menke.com
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fax or email this information back to our home office and we will then give you a call to discuss our findings
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and to discuss the feasibility of an esop to accomplish your objectives again if you’d like to have us perform a
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free feasibility analysis please give us a call at 800-347-8357
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or you can complete the questionnaire form by clicking the button at the top of the screen
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thank you for attending our estop website seminar and again we look forward to talking with you at your earliest convenience
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you