Jun 10, 201311:20 AMThe Bottom Line
with contributors from Associated Bank
The benefits of employee stock ownership plans
(page 1 of 2)
One of the most difficult problems for owners of closely held businesses is finding a way to partially or completely monetize their equity interest in a business. Most often this complex subject arises during estate, retirement, or management succession planning discussions that, because of potentially significant economic and deeply personal considerations, may be extremely challenging matters to resolve.
Business executives are beginning to see the importance of tackling another seemingly unrelated challenge – deepening employee engagement. Leading research and consulting firms such as The Gallup Organization, McKinsey & Co., and The Hay Group have documented the real and significant impact of employee engagement on customer loyalty, financial profitability, productivity, employee turnover and absenteeism, patient incidents, or production/installation error rates. Given its importance to performance outcomes, business leaders now consider engagement an essential component of their business strategy.
Interestingly, employee stock ownership plans (ESOPs) may address both of these situations. The ESOP is a corporate finance tool that enables business owners to sell all or a portion of their ownership interest to an unrelated trust for the benefit of participating employees.
The value of ESOPs in the estate and retirement planning process
When developing an estate plan, which includes ownership interests in a private or public company, ESOPs can be a very attractive and tax-favored corporate finance alternative. For example, the owner of a C-corporation may be able to defer sale-related capital gains taxes by selling his or her ownership interest to an ESOP and reinvesting in select corporate securities. If these securities are not sold prior to the owner’s death, no capital gains tax is ever due. In the case of limited liability and S-corporations and partnerships, undergoing a legal conversion to a C-corporation before the sale may permit the owner to take advantage of this tax deferral. Alternatively, if the company remains an S-corporation, the owner does pay capital gains tax on the sale but reaps all the other benefits of selling to an ESOP.
Additionally, an ESOP may be appropriately structured to accommodate selling owners interested in remaining active with a business. While ESOPs are governed by independent trustees who vote the shares, the board appoints the trustees, so changes in corporate control are usually nominal unless the plan is set up by the company to give employees more input at this level. An owner may sell his or her ownership interests in a single, one-time transaction or may find value in structuring a gradual sale over a longer period of time.
Lastly, in this situation, an ESOP evaluating estate-planning alternatives may help to address some of the emotional or qualitative considerations of investing time, energy, and personal capital that often arise. After investing years in a business, an owner typically develops a strong feeling of identity with the company. At the same time, the owner often has a sense of loyalty to the employees and would like to see them have a continuing role in the company. For some business owners, the answer to these problems is to transfer ownership of the company to a family member or sell to a competitor, but those options may be unrealistic for others. Thus, those looking for an alternate solution should consider an ESOP, the outcome of which would be, at minimum, on par with what a financial buyer is likely to pay.