ESOPs for Architectural & Engineering Firms

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hello this is john menke president of menke and associates inc and welcome to our webinar presentation
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on esops for architectural and engineering firms
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before we begin if you’re having any problems viewing the presentation give us a call call at 415-362-5200
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and ask for jeannie kluga that’s
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415-362-5200 also before we begin let me review a few logistics
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this webinar program is presented in broadcast mode which means that you can hear us but we
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can’t hear you as we’re going through our presentation you can submit written questions
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by using the chat function on your screen and we’ll try to answer these questions at the end of the presentation
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we’ve reserved about 15 minutes for these questions and answers at the end of the webinar
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if we don’t get to all the written questions today you can give us a call or send us an email afterwards
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and we’ll get back to you later today or tomorrow with the answer today’s
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presenters will be myself and chuck bachman and the presentation will be in a question and answer
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format i’ll ask a series of questions regarding how esops can be used
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by architectural and engineering firms to accomplish various goals and objectives and then chuck bachmann bachmann will
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provide the answers based on his knowledge and experience in designing esops for hundreds
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of architectural and engineering firms chuck is both an arisa lawyer and a cpa and he’s been a member of our
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firm for over 15 years by way of background minikin associates
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is the oldest firm in the country specializing in esop our firm was founded in 1974 and this
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year marks our 30th 35th anniversary of designing and installing esops
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over the past 35 years we’ve created more than 2 500 esops more than any other firm in
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the country we also administer about 800 esops and we have
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eight offices throughout the united states let me begin by defining what an esop is
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an esop is many things to many people to the existing shareholders it’s a buyer of stock that
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simultaneously offers tax savings to the seller and an orderly succession plan for both majority and
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minority shareholders to the company the esop is a technique of corporate finance that
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enables the company to finance growth and expansion and or shareholder redemptions with tax
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deductible dollars while simultaneously providing a highly effective employee and senate plan
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to the employees an esop is a company-funded retirement plan that offers them an incentive and a
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reward that’s usually unmatched by any other type of retirement plan
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it’s important to note that an esop consists of both a plan and a trust and that the trust is the
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direct owner of company stock not the employees typically the company owners are designated as the planned
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trustee or trustees employees will receive annual statements reflecting their account balance in the
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usa however they are 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 with any when an esop is
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implemented even when an e-stop owns the majority of the stock
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chuck now i’d like to ask you the first question why is it that esops are popular with owners of privately held businesses
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well john over the past 35 years esops have been increasingly popular among privately
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held firms because they offer a number of tax and financial advantages that are not available under
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other alternatives the most frequent use of an esop for example is to create partial or total liquidity
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for existing shareholders esops are uniquely designed to accomplish this objective
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the great majority of cases in the great majority of cases the primary purpose of the esop
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is to create an in-house market for existing shareholders the advantage that an esop brings to the
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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 c-corporation congress has provided a special tax incentive to
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encourage companies to use esops for shareholder liquidity in this special tax provision if the
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esop acquires 30 or more of the stock of a privately held company the gain will be deferred provided that
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the selling shareholder reinvests the proceeds in qualify qualified replacement
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property in the case of s corporations there is also an advantage to using an esop to
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create shareholder liquidity rather than utilizing a stock redemption the advantage of selling to an esop
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is that any amount of stocks sold to the esop will qualify for favorable capital
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gain rate which is currently under the tax code is about 15
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at the federal level the reason why esops have been increasingly popular
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whether the company is a c corporation or an s corporation is an esop can help a company
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substantially eliminate the payment of federal and state income taxes on the earnings of the company we will
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discuss the techniques for doing this more in more detail later in the session the
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third advantage of using an esop 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 as a company yet still retain control even after the selling the majority of
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the stock to the esop the fourth advantage of using an esop
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is that the monies the esau borrows in order to buy out existing shareholders can be repaid with tax deductible
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dollars that is the company will be able to deduct not only the loan interest as can be done in the stock
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redemption but also the loan principal this is unique to esop’s
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last but not least when properly implemented and communicated and esau can have a dramatic effect on
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increasing employee productivity this in turn can result in increased profitability
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and an increase in the overall valuation of the company
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as a result of the various tax and financial benefits that esops have to offer there are now over
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11 400 esops currently in existence in the united states
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and these esops cover over three 13.7 million participants it’s 13.7 million
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it is estimated that the total value of all esop assets is about 900 billion
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now i’d like to talk about how eesops can be used by owners of architectural and
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engineering firms chuck what are the common ownership problems that are faced by the owners of
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architectural and engineering firms well john the common ownership problems that are faced by owners of
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architectural and engineering firms are in general the same problems that are faced by all owners of privately
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held businesses namely the lack of liquidity lack of diversification
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and the need for a succession plan fortunately the esop is one of the tools that can
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prove provide an answer to all three of these problems it can provide liquidity and
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diversification for the existing owners and it can provide an orderly business succession strategy
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as a liquidity tool the esop offers a number of advantages the esop creates an in-house market
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whereby existing owners can sell their shares as and when they see fit unlike a sale
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or merger an esop allows the owner to sell part of their shares rather than selling the entire company
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thus the owners can sell their shares over a period of years rather than selling them all at once
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since the esop creates an in-house market no outside party is involved and there is certainty of the outcome
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also the cost of arranging a sale to the esop is a fraction of the cost that would be incurred in a sale to a third party
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as a tool for investment diversification esop allows you to diversify whatever
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amount of stock you wish to liquidate and invest in other investments such as cash and fixed income securities
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or equities the mix of investment selections is entirely up to you
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as a tool for business succession the esop is probably the least stressful method of
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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 the outcome and there is less likelihood of employee layoffs
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and or changes in management in fact an esau purchase can also be combined with a
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management buyout tool so that the men also acquire a significant equity in the company
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the particular advantage that an esop offers is that it can provide for a gradual change of ownership to the
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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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well chuck it’s easy to see that esops offer a number of financial and tax advantages not offered
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by other alternatives but why is it that esops are especially popular with architectural engine
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and engineering firms yes i think esops are especially popular with architectural and engineering firms
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because these firms are by definition service businesses where the success and profitability of the firm depends almost
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entirely on the productivity of the employees also the bulk of the employees in
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architectural and engineering firms are professional employees who expect over a period of some years to become
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partners in the business since most architectural and engineering firms are now structured as corporations
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rather than partnerships this means that they expect to be shareholders in the company after they’ve been with the firm a number of
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years the disadvantage of operating as a corporation is that much more it’s much more
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difficult to transfer shares of stock to a new employee shareholder than it is to assign a
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partnership interest to a new partner if for example the company simply issues newly issued stock to a new employee
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shareholder employee shareholder will recognize ordinary income for the fair market value of the stock
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in addition issuing newly issued stock to a new employee shareholder does nothing to
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create liquidity for existing shareholders who might desire to liquidate or part
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with their shares some are all of their shares another reason why esops are
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so popular with architectural and engineering firms is as a general rule these types of firms provide prefer to
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be locally owned and operated unlike manufacturing and other types of
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industrial type firms it is more common for architectural and engineering firms to be acquired by
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their managers and employees than to be acquired by a competitor a public company
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or by a financial buyer such as a buyout firm the third reason why architectural and
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engineering firms utilize esot is that the esop can be a very useful tool in helping the company attract
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and hire high quality employees again professional employees are much more
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inclined to accept a job offer from a company that provides for stock ownership than a company that provides no such
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ownership opportunity lastly esops are popular among architectural and engineering firms
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because these types of firms fully recognize that their professional associates are in fact their most valuable asset in
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the absence of an esop or similar type program there is always the risk that the key
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employees will simply walk out the door and start a competing company for all
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the foregoing reasons i think esau are especially a good fit for architectural and
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engineering firms in fact we have done more esop for architectural and engineering firms than any other single industry
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well chuck given that esops are in general a good fit for architectural and engineering firms
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are there any situations where nesaf is not a good fit for an architectural and engineering firm
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yes there are a few situations john where the esop is not a good fit one such situation would be where the
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firm is simply too small to have an esop as you know we have done esops for companies with as few as 10 employees
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and as many as 10 000 employees however it is usually not economical to install
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or maintain an esop if the company has fewer than 10 employees in addition if the company is an s
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corporation and has 10 or fewer employees it can also be difficult with the so-called quote
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anti-abuse provisions unquote which are set forth in section 409 small
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p of the internal revenue code if the company can cannot comply with these provisions then
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it will either forego becoming an esop or convert to c corporation status
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the second situation where the esop is not a good fit for a company is relatively new and not
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as a company it’s not relatively new and not profitable in order for an esop to be most effective the company needs to be profitable in
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paying taxes
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well as shown by this slide esops are used for four principal purposes one to create
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liquidity and diversification for sellers two to increase employee productivity
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three to increase company cash flow and four to provide for business
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diversification let’s start by discussing how esops are used to create liquidity and
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diversification for sellers chuck how are esop transactions typically structured to
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create liquidity and diversification for owners of architectural and engineering firms
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john pretty much the same at the same time as they’re structured for other types of firms
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are in the same manner they’re structured for other types of firms how the esop is structured depends upon the goal
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and goals and objectives of the current shareholders esops can be extremely flexible in how
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they are structured for shareholder liquidity purposes and in general there are three basic
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ways an esop can be structured first is what i call a quote pre-funded
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unquote esop a pre-funded esop is one where the esop is established and the company makes
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contributions to the plan and cash which is accumulated to be used as a at a later date to purchase stock from the
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shareholders many companies start out by using a
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pre-funded esop as a way to generate current tax deductions and as a way to accumulate cash in the
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plan where for one reason or another the current shareholders are not willing to start selling their shares
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under the current internal revenue code provisions a company is allowed to make a tax deductible
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contribution each year in any amount up to 25 of eligible payroll that’s for example
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eligible payroll is one million dollars it can make a tax deductible
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contribution of up to 250 000 per annum thus if the company
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contributed the maximum amount each year after a period of four years the plan would have accumulated a piggy
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bank of at least one million dollars in funds plus however much interest they may have
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earned on those funds many times the company is already sending these funds at a 401k match or
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profit sharing contribution which do not have the flexibility to invest
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a gradual esop is one where the company makes discretionary contra contributions each year up to the
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maximum deductible amount and uses these contributions to purchase shares from existing shareholders
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on a year by year basis the advantage of this approach is that it is highly flexible
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the company’s complete discretion as to how it contributes to the plan each year
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the advantage to the selling shareholders is that it they’re only selling a small percentage
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of their stock from year to year however unlike a stock redemption each
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and every sale to the east up
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and once the esop is acquired 30 percent 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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are true is used where 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
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as i mentioned earlier in order to qualify for the tax deferral
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funded the esop will usually have to be leveraged in order to have funds to purchase 30 percent of the
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outstanding stock how is the plan leveraged does the plan borrow money or does the company borrow
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the money good question john let me explain this by giving a specific example
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let’s assume 10 million dollars an eligible payroll of 1 million pre-tax
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profits is 600 000 and a fair market value of three million
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let’s further assume that the esop wants to purchase thirty percent of the outstanding stock
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for a purchase price of nine hundred thousand dollar dollars as the bank lends 900 000 to the company
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and the company then lends 900 000 to the esa
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the esau then purchases 30 of the outstanding stock of the company ship from company shareholders for nine
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hundred thousand dollars in cash [Applause]
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where the company then makes a tax deductible cash contribution to the esop
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an amount up to 250 000 plus interest the company then uses the contribution
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i’m sorry the ethos then uses the 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 135 thousand
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to 180 000 in federal and state taxes depending on what state income tax rate
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we’re using of course these structures can can be combined if
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useful and necessary case four for example combines the pre-funding and the
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leveraged ideas of cases two and three in this slide for example you will note
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that the company pre-funded the esop for two years accumulating about four hundred thousand
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dollars of cash meanwhile market value of three million
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to three point thirty three for three million three oil grew from three million to
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three million three hundred thirty thousand at the end of the first third year in order to reach the 30
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threshold the company needs to own one [Music] loan need needed only to be 600
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000 which is 300 000 less than would have been required if no pre-funding had occurred therefore the required loan
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is reduced by 33 percent and the annual debt service is reduced by by over 81
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000 a year case five combines year by year
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purchases with tax deferred sale in year four
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as shown by the slide at the end of the first year the company would purchase three percent
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at the end of the second year year the esop would hold 12 percent
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each of these sales would be taxed at capital gains rates however the sale in year four would
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result in esop owning 30 thus the seller would be able to elect tax free rollover with respect to the
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stocks sold to the esop in year 4. case 6 illustrates how the esop can be
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structured to accomplish a hundred percent buyout in most cases it is not possible to
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obtain financing to accomplish a hundred percent esau buyout in one fell swoop
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accordingly a 100 percent esau
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in the first stage for example the esop might be leveraged in amount sufficient to buy fifty percent of the outstanding
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stock then after this loan is paid down the plan could be re-leveraged in year 4
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to buy the remaining 50 well chuck what if there was more than
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just one shareholder of the company what if there’s a majority shareholder and one or more
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minority shareholders can esop offer to buy off the majority shareholder without also
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making the same offer to the minority shareholder in most cases the shareholders will
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readily agree among themselves as to what whether the esau is to be used to purchase part
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or all the stock of a majority stock of a shareholder or part or all of the stock of one or
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more of the majority shareholders or a combination of the two however if for some reason the
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shareholders cannot agree among
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themselves
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okay you’ve mentioned a couple of times earlier that in the case of a c corporation there’s a special provision of the code
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that allows the selling shareholder to receive the proceeds on a tax deferred or
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tax-free basis can you tell us a little more how this works yes john under section 1042
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of the internal revenue code if an esop acquires 30 percent or more of the stock of a privately held
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c corporation the capital gains tax on the amount of gain will be deferred
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provided that the seller reinvest a like amount of money in qualified replacement property within
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12 months from the date of sale this tax deferral will continue
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as long as the seller holds the qualified replacement property if the seller holds the property until
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his death then it will receive a step up in basis
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qualified replacement property consists of stocks or bonds of american corporations the
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corporations may be big or little public or private but they must be american
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the seller cannot invest in mutual funds or in government securities unless he is willing to pay capital
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gains tax most sellers who elect a tax deferral wind up investing the proceeds in a
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diversified portfolio of corporate stocks and corporate bonds a seller can always sell
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part of his replacement securities later on to the extent that he does so however
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he will have to pay capital gains tax that was previous to for the capital gains tax that was
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previously deferred as well to gain on any subsequent appreciation as well
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well chuck is there is there any way to avoid being locked into these replacement securities and having to
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hold the spam investment portfolio until death yes there’s simple there’s a
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relatively simple way around this problem and that it is to purchase long-term
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esop bonds and then margin out 80 percent to 90 of the proceeds
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for example assume the seller receives 900 000 from the sale of stock to the esop
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he or she could then purchase 900 000 worth of long-term esop bonds
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and then this purchase would satisfy the requirement that the seller must purchase qualified replacement securities the
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seller then could margin out say 720 000 of the proceeds and invest these funds
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as he or she sees fit now chuck you mentioned earlier that the tax free rollover provisions
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don’t apply to shareholders of an s corp are there tax advantages that do apply to s-corps
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on the other hand that don’t apply to c-corps yes as you know in the case of
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s-corporations all the earnings of the corporation are taxed at the shareholder level rather
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than the corporate level as you also know the esop is a tax-exempt entity
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thus to the extent that the stock of an s corporation is owned by an east stop part of the corporation’s earnings
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will be exempt from income tax thus in the case of an s corporation that is 100 percent owned by an esop
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none of the corporations earnings will be subject to income tax the esop era s corporation earnings
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is also exempt from the unrelated business income tax there are also there are only two
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disadvantages to s-corporation esop the principal disadvantage
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is that there’s no tax-free rollover available to the seller for s corporation usaps they must pay
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their capital gains tax on the sale the second disadvantage is that s
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corporation esops must cover a broadly based group of employees under this test if disqualified persons
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owned more than 50 percent of what is called quote deemed owned shares unquote
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then the esop share of the earnings will be subject to the unrelated business income tax and the disqualified
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persons will be subject to certain excise taxes
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chuck in in view of the fact that in the case of s corporation esops the tax benefits accrue
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more for the benefit of the company itself rather than for the benefit of selling shareholders
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are esop transactions structured differently for s corporations than for c corporations
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well basically all the same transaction structures that are used for c corporations are also used for s
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corporations as in the case of c corporations with s corporation esops
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structured as pre-funded esop some are structured as gradually subs where the esop purchase shares year by
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year and some are structured as leveraged ease off however because of the fact that the
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company will be 100 tax exempt if the esop is the sole shareholder
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we may have seen more 100 percent esau buyouts of s corporations than we have seen in the
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case of c corporations also because the difficulty in securing 100
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bank financing for a buyout many of these transactions have been structured with 100
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seller financing here is an example of how leveraged esops are typically structured
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for s corporations in this example the owner barbara is the sole shareholder and pays herself
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a salary of two hundred thousand dollars a year there are twenty other employees that
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have a total compensation of eight hundred thousand so that barber’s compensation is twenty percent of the
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total payroll the company has a value of four million dollars
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case seven shows how the transaction will be financed with seller financing in this case barbara becomes the banker
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herself by taking back an installment note from the esop barbara will receive installment
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payments over the term of the node as she receives the principal she will
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have to pay capital gains tax on the portion of the principal payment that represents gains
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and she will pay ordinary income tax on the interest portion but the important thing to point out is
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that the esop now owns a hundred percent of the company the company no longer has to pay income taxes
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assuming a pre-tax profit of eight hundred thousand dollars this would result in a tax savings of
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over three hundred thousand dollars that would otherwise have been paid and kept each year
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and every year in taxes the same 300 000 that can be used can be used instead
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for a large to pay a large portion of the installment payments that will be paid to barbara each year on our installment
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notes the next slide illustrates two points about leveraged esops
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first it illustrates how debt is repaid in the case of an s corporation the debt
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is repaid by having the company make tax-deductible contributions to the esop which the esop then uses to make note
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payments to barbara in the case of an s-corporation the debt can also be repaid by using
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s-corporation distributions that are paid to the esop and then used to make payments on the no
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payments to barbara debt is repaid the same way c corporations
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except c corporations aren’t allowed to make s-corporation distributions to shareholders instead there’s a special
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code provision that allows c-corporations to pay so-called quote deductible dividends and quotes
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to the esop over and above tax deductible contributions
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normally c corporations don’t pay dividends because these dividends are not tax deductible
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in the case of an esop however if they’re used to repay esop debt the dividends will be tax
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deductible the second point of this slide is to illustrate how stock is allocated in the
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case of a leveraged esa in the case of a gradual esop obviously
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the stock allocated on a year by year the stock is in gradually stop obviously the stock is allocated on a year by year
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basis as and when the shares are purchased in the case of a leveraged esop
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stock is allocated to participants as note payments are made thus if the esop purchases 100 of the
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outstanding stock all the stock is initially held by the esau in a suspense account
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then each year the company makes contributions to the plan and the contributions are used to make
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note payments to the seller or to the bank lender if the bank is involved
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a pro rata portion of the shares is released from the suspense account and allocated to the accounts of the
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participants the block of stock that is released from the suspense account each year is then allocated
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among the accounts of the participants in proportion to covered compensation
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the other alternative for structuring a leveraged esop is to have the transaction financed with a bank loan
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rather than a seller note thus if barbara wants to get her cash right away for the stock
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then external bank financing would be required in order to put four million dollars into barbara’s
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pocket right away thus case eight and is the same as case
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seven with the exception that a bank is now involved the concept however is exactly the same
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the esop owns 100 of the company therefore the company pays no taxes and the lender is being repaid with
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pre-tax dollars that’s because the company is now exempt from paying any taxes
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whether the esop is bank finance or seller finance the results will be the same in either case
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first the company’s earnings will no longer be subject to income tax second barbara rule will receive
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four million dollars and will pay capital gains on her gain
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third since barbara’s compensation constituted twenty percent of the total covered compensation
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barbara will be allocated twenty percent of the stock within the esop and she’ll 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 a c-corporation
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where the seller has sold stock to the esop and elected the tax-free rollover treatment
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in that case there’s a special rule that prohibits the seller and the sellership the seller’s
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shareholders and related parties from receiving any allocation of stock that is sold
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in the tax-free section 1042 rollover transaction
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fourth since the earnings of the company are no longer subject to income taxation the company no longer has to make
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distributions to the shareholders to enable them to pay their taxes instead these funds can now be used to
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repay debt after the debt is repaid these funds can be accumulated in the company
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and used to make acquisitions or to otherwise fund growth and expansion
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okay so far we’ve talked about esops being used to create liquidity and diversification for the shareholders
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a second use of esops is to increase employee productivity
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sometimes the primary purpose for adopting esop is simply to create a direct link
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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
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car the concept of an esop is to have employees think and act like owners
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so chuck the obvious question arises do esops in fact really increase employee
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productivity yes john numerous studies conducted over the last 17 years have
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all included that have all concluded that esop increased company performance for
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example one of the early studies found that employee absenteeism went down by 66
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and employee turnover went down by 50 percent after implementing an esop more recently
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there were two harvard business review studies that found that sales growth in esot companies was
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significantly higher than incomparable non-us companies
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more importantly two independent studies won by northwestern universities kellogg school of
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management and one by hewitt associates both found that esop companies have a higher return
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on assets and a higher return on shareholders equity than comparable non-usopp companies
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well chuck what is the impact of increased employee productivity on profitability and the overall value
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of the company is this impact relatively nominal or is it significant
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well the impact can be quite significant this slide illustrates for example a 2 increase in productivity that
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literally results in a 50 increase in profitability in this case we assume the company had
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10 million in revenues and a pre-tax profit of four hundred thousand
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as indicated if the sales force can be increased uh increasing if the sales force can
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increase revenues by two percent that hold expense constant the pre-tax profit
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increases by fifty percent another way that profitability could be increased by
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fifty percent would be if the employees were able to reduce expenses by two percent while holding revenues constant
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of course the employees can both increase revenues by two percent and reduce expenses by two percent then
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the company would literally experience a hundred percent increase in
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profitability the third use of an esop is to increase corporate cash flow
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this can be accomplished by simply having the company contribute newly issued stock or treasury stock to
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esop over a on a year by year basis the result is to reduce corporate taxes
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and increase cash flow while simultaneously providing a retirement benefit for the company’s
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employees chuck what are the pros and cons of using an esop to increase company cash flow
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as you mentioned the principal advantage of using an esop to increase cash flow is that the company’s cash
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flow and net net worth will be increased the potential disadvantages
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disadvantages using new shares of stock to the esop will create dilution to the original
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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 that would be made to
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some other form of retirement plan as illustrated by the slide for example
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if the company contributes three hundred thousand dollars worth of stock to the esop and
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lua the three hundred thousand dollar 401k matching contribution
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or profit sharing contribution the company has the effect of receiving 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 the shareholders if the company does
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not spend the money wisely then there’ll be dilution to the shareholders equity
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okay the fourth use of an esop is to create a succession plan for existing
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shareholders in my view any esop transaction is the least
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stressful and most efficient means of transferring ownership to the next generation for three primary reasons first the esop
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utilizes pre-tax cash flow rather than after tax cash flow second it’s usually done in stages and
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therefore involves plus leverage and third it usually involves no change in management control
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at the offset in most cases there’s only a gradual change of management control
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over a long period of time chuck what’s your view of esop as a tool
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for business succession in the area of business succession and transition an esop
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on its own is usually not the sole answer to one’s objective for example many owners wish to reward
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their key employees as well as certain family members in addition to the esau participants
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stock sales can be made directly to key groups of employees and stock grants can be made to family
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members in many if not all cases we recommend creating a separate non-qualified management stock bonus
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plan that is created specifically for the key employees who will be responsible for the
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long-term growth and succession of the business chuck we’ve talked about the various
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advantages of an esop what are the disadvantages of an esop
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well john there are several potential disadvantages of an esop depending on the facts and circumstances however in most cases the
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alleged disadvantages are perceived rather than real
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one potential disadvantage of a sale to an esop versus a sale to a third party is that any sale to an esop
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depends on the ability of the company to obtain the necessary financing if the transaction is financed with a
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bank loan the company must have the ability to obtain the necessary bank loan
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based on having sufficient cash flow to service the loan and sufficient assets to collateralize
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the loan if the company does not have sufficient collateral the seller may have to use personal
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guarantee or may have a pledge have to pledge a portion of the qualified replacement
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securities on the other hand a seller can always self-finance the sale in whole or in
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part if sufficient bank financing is not available
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another potential disadvantage of an esop sale is that the debt incurred to finance the
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transaction will will reduce the company’s net worth this is no different than in the sale
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with a stock redemption or a management buyout and in most cases has little or no impact on the company’s operations
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the only case where it does have an impact is in the case of construction companies where the required whether construction
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companies require to obtain construction bonds if the company’s net worth is greatly
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diminished the company may have difficulty in obtaining the necessary bonding in general shareholders of construction
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companies should sell their stock gradually over a period of years in order to avoid any sudden reduction
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in net worth shareholder dilution is another potential esau disadvantage
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shareholder dilution comes only about when the esop is funded with newly issued shares of company stock
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since most esops are funded with cash which is used to purchase shares from existing stock
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rather than newly issued stock dilution seldom comes into play even if the esop is funded with newly
43:44
issued shares the dilution is usually not that significant as illustrated by the slide
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in fact if the cash flow savings are put to good use the dilution becomes an advantage rather than a disadvantage
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to the extent that it enables the shareholders to own a smaller piece of a bigger pie a common misperception
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is that the esop results in a loss in control this is not true in an esop the board of
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directors appoints the controlling shareholder as the plan committee and trustee of the plan
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thus the controlling shareholder continues to vote the shares as he sold to the plan as well as the
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shares that he still owns outside the plan the plan committee directs the voting of
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all the ethos shares on ordinary issues such as the annual election of the board of
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directors thus there is never any loss of control the only exception is that the
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participants in the plan are allowed to vote on certain quote special issues unquote the special issues that
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participants are allowed to vote upon include only mergers consolidation
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recapitalization liquidation or sales substantially all the corporate
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assets and even on those special issues however participants are only allowed to vote
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with respect to those shares that have been allocated to their account all unallocated shares are still
45:19
voted by the trustee also participants do not vote
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upon a proposed sales stock to a third party since this is a fiduciary decision not a
45:30
decision that requires a shareholder vote it is important to note that having an
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esop does not take away any of the other shareholder liquidity options the controlling shareholder can
45:42
still sell its remaining non-esight shares to a third party and the plan committee
45:48
you can still elect to sell all the esop shares to a third party
45:53
another misconception is having the esop will require the company to disclose confidential financial information
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again this is not true the only disclosures that are required are that the participants must be
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furnished with an annual benefit statement which discloses their total account balance
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their percentage vesting and the per share value of their stock
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having an esop does not expose the trustee to any great fiduciary liability than would be with the
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fiduciaries or trustees of a pension for profit sharing plan in fact the fiduciary liability is
46:30
somewhat less since the trustees and stops are exempt from the normal requirements to earn a fair rate to
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return to diversify the investments and provide investment liquidity
46:44
yet another misconception is that having an ethos equip record creates a repurchase liability for the stock
46:50
that is acquired by the ethos the fact of the matter is that all stock
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ultimately needs to be repurchased that is why stock has value the difference is
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with an esop the repurchase of such stock will be spread out over the lives of the planned participants
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and will be made out of tax deductible dollars whereas in the case of a stock redemption
47:13
or the repurchase will come due all at once upon the death or retirement of the owner
47:18
and will be made with after-tax dollars lastly it should be noted that selling
47:24
to an esop unlike a merger or a sale to a third party is not an
47:29
irreversible decision if you change your mind esop can be terminated
47:34
and all the shares distributed and repurchased in the alternative an east sub can also
47:41
be frozen and the shares can be gradually repurchased as employees die or retire
47:48
thanks chuck that covers our presentation of the pros and cons of
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esops this next slide shows the services that our firm provides in designing installing administering
48:00
and evaluating esop companies the
48:06
design and installation services include preparation of the formal business appraisal
48:11
financial consulting regarding the transaction itself drafting all the legal documents
48:17
securing irs approval of the planned documents preparing the employee communications
48:23
booklets and conducting powerpoint presentations for the employees
48:28
and finally a system of setting up the accounting and administration systems required to to administer the usa
48:36
on an annual basis we’re available to provide the annual record-keeping services keeping the plan in compliance with irs
48:43
requirements as well as preparing the individual employee benefit statements
48:48
and in addition we also provide the annual update of the stock appraisal so that the
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employees can see the value of their their shares critical we believe if you’re installing
49:03
any stock to use a firm that that’s a specialist in this area with an experienced firm the full
49:10
services will be provided at less cost to the client and probably with fewer errors
49:15
incurred in the process as we mentioned earlier mention search has designed over 2500
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esop since our inception and we’re the most active firm in the country in esop activity
49:28
headquartered in san francisco and we have offices in los angeles las vegas chicago atlanta chesapeake maryland
49:36
wilmington delaware naples florida and our appraisers are located
49:41
throughout the country as well but how do you know if your business is an appropriate candidate suitable for an
49:48
e-stop well just take a few minutes to complete the confidential feasibility
49:54
questionnaire from our website at mentee menke.com www.meninkey.com
50:02
or you can fax or email this information back to our home office and then we’ll give you a call to discuss
50:08
our fine things and to discuss the feasibility of an esop to accomplish
50:13
your objectives so if you again if you’d like to have a free preliminary analysis
50:19
give us a call at 800-347-8357
50:25
or complete the questionnaire on our website by clicking on the button at the bottom
50:31
of the screen thank you for viewing our presentation
50:36
and now we’ll if you haven’t already you can submit some written questions and
50:41
we’ll try to answer as many of them as All For you