Money Management - June 2005

Employee Stock Ownership Plans

An Alternative Way to Sell Your Business

by Matthew D. Goedert

Have you ever tried selling a minority share of your privately held business? Did it feel like you were selling beachfront property on the moon? There is an easier, more profitable way for you to liquefy your assets and diversify your stock.

As a successful business owner, you may know one of the most difficult endeavors is to convert the company’s equity into cash. You may be worth $5 million on paper, but your inability to exchange equity into cash may be affecting your current lifestyle or retirement plans. Don’t be discouraged. This is a common problem for many privately held businesses. Although a business owner has several alternatives when deciding how to proceed, using a retirement plan might be the best alternative.

Many owners are unaware that they can sell the stock to a retirement plan known as an employee stock ownership plan (ESOP). An ESOP is not a typical retirement plan; it is designed to invest primarily in company stock. A company using an ESOP as a pass-through conduit may be able to borrow money at a preferred rate from a bank to purchase the stock, due to the tax benefits. When an ESOP purchases at least 30 percent of the company stock, the sale qualifies for tax-free "rollover" treatment as long as the selling shareholder buys other qualified securities.

Thus, the owner can diversify his portfolio in preparation for retirement. In addition to tax benefits and liquidity, in many cases owners can sell 51 percent or more of the company to an ESOP and retain effective control. Depending on the company finances, the ESOP can purchase all the stock over a period of three to seven years, and in extremely rare cases the ESOP is able to purchase 100 percent of the company in one transaction.

The positive financial impact on the company is simple. Borrowing funds to repurchase an owner’s stock with an ESOP loan allows the company to deduct the principal repayments on the loan as well as the interest. If the company borrows $5 million for the purchase price, the company will be entitled to $5 million in federal income tax deductions for repaying the loan. This results in a $1,750,000 federal tax savings over the term of the loan. Combined with the $750,000 in deferred capital gain taxes for the seller, the total tax savings can be at least $2.5 million, or 50 percent of the purchase price.

There are other benefits as well. Through their indirect participation, employees will share in both the profitability and long-term growth of the company. Similar to the way pension and profit-sharing plans benefit employees, an ESOP can defer taxes for retirement benefits. Studies have shown that an ESOP can result in increased employee productivity and reduce employee turnover.

ESOPs are not for everyone. Some business owners are not concerned with liquidity, may not be contemplating retirement, or may want to retain sole ownership of their company. ESOPs may be inappropriate for businesses that are unprofitable or have only a short-term industry outlook.

There are many ways to liquefy and diversify your stock, as well as provide for your retirement. ESOPs provide a viable solution by creating a ready market for privately held company stock, while maintaining employee interest and profitability. An ESOP will also allow you to diversify your investments on either a tax-free or tax-deferred basis. When it comes time to retire or sell part or all of your business, consider an ESOP and the rewards it can provide for your loyal employees and your own pocketbook.

Matthew D. Goedert
Matthew D. Goedert is a partner in Goedert & Associates, a Reno-based law firm focused primarily on employee benefit plan matters.