There are many ways for a business owner to successfully plan for his/her exit. A survey conducted by the Business Enterprise Institute, Inc. shows the break down by successor type as follows:
|Business owners who exit plan: owner's choice of successor|
|Key employee(s), co-owner, ESOP||41%|
The largest allocation of 41% is to key employee(s), a co-owner, or an employee stock ownership plan (ESOP). As of 2013 there are almost 11,000 ESOP plans for over 10 million employees in the United States. An ESOP is a viable option for many business owners.
What is an ESOP?
An ESOP is a private company qualified retirement plan that allows for employee participation in corporate ownership. ESOPs are governed by the Employee Retirement Income Security Act (ERISA), a federal law that establishes minimum standards for pension plans in private industry. An ESOP is a mechanism to offer the employee an equity stake with the chance to build significant net worth along with a long-term career.
How an ESOP works?
The way an ESOP works is that the company sets up a trust fund for employees and contributes either cash to buy company stock, contributes shares directly to the plan, or has the plan borrow money to buy shares. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan.
Benefits of an ESOP
- Contributions to the ESOP are tax deductible.
- ESOPs provide shareholder and/or corporate liquidity. Pretax dollars become available to finance company growth and/or to create ownership liquidity at the time of individual employee retirement.
- Rollover of gains. Provided that an ESOP owns 30% or more of company stock and the company is a C corporation, IRC §1042 allows the seller of the stock to defer capital gains tax as long as the proceeds are reinvested in securities of other companies within a 15-month window, 3 months leading up to the transaction and 12 months after the date of sale.
- S corporation benefits. If the company is an S corporation, the ESOP’s share of earnings is not subject to federal or, in many states, state corporate taxation, nor is it considered “unrelated business income taxable.”
- Increased owner control of business identity and business continuity. When an owner is prepared to sell a personal stake in the company, an ESOP provides a vehicle whereby the company can literally be turned over to known and trusted employees, rather than lose its identify through a merger or acquisition.
- Improved morale. Studies have shown that offering employee ownership in most cases results in increases in production and morale.