ESOP fables (and truths)

When many business owners think of Employee Stock Ownership Plans (ESOPs), they think of negative examples like the bankrupt Enron and like United Airlines, a company that adopted employee stock to off set the financial stress of huge wage concessions.

But a strategically planned and financed ESOP has benefits that other buyout and succession plans do not, including a larger return for investors, tax-deferred capital gains, flexible liquidity and creative financing options.

As ESOPs shake their stigma, mid-range businesses from manufacturing to straight service are taking advantage of the willingness of financial institutions to guide and fund owners through the process of converting to an ESOP.

Liquidity and control

ESOPs are complex — there are IRS, ERISA and other fiduciary issues to contend with. However, for business owners who want to diversify while maintaining decision-making power, it’s a great option.

Many closely-held business owners like the fact that an ESOP is more flexible and nonintrusive than a straight buyout or acquisition. And an ESOP will net as much as a traditional buyout, albeit not right away. And if done correctly, it can defer capital gains.

This works because an ESOP trust buys into a business based on its fair market value, just as any other investor would. This allows the business to have access to capital without going public or affecting cash flow.

Succession planning

After years of hard work and reinvestment, company founders are finding themselves with a highly valued business and a zero tax basis in their own stock.

Assuming state and federal capital gains taxes at a 30 percent rate, this means that a straight sale to a third party or allowing the business to go to probate has large, often unmanageable tax implications.

With a combination of an ESOP-leveraged transaction, proper tax planning and a gifting schedule, business owners can defer or avoid taxes on wealth transfer from one generation to the next.

Creative financing

Because an ESOP is a variation of a stock bonus or purchase plan that invests back into the company, it can borrow from or on the credit of the employer.

ESOPs allow more creative and leveraged buyouts without the tax implications and have shorter loan payback schedules because the company deducts interest on the debt as well as on the principal payments.

Another advantage for mid-range businesses is that ESOPs can be funded by a combination of means, including senior notes, seller notes, cash and 401(k) employer matches so as not to restrict cash flow.

Guidance and advice

As with any business plan that includes dealing with the IRS, ERISA, and state and federal laws, ESOPs require the guidance of an experienced fiduciary trustee or counselor. An ESOP trustee helps with valuation and financing, tax and qualified plan compliance monitoring, voting and shareholder issue, as well as employee communication.

For the increasing number of closely-held and mid-range business owners who are facing succession and liquidity issues and for business not interest in going public, ESOPs present a valid and tax-friendly alternative. Roy D. Hasbrook ([email protected]) is senior vice president/division manager of LaSalle Bank’s Northern Ohio Lending Division in Cleveland. His office is responsible for developing new banking relationships with mid- to large-cap companies throughout Ohio.

LaSalle is uniquely positioned to help its customers succeed in the international marketplace. As a subsidiary of ABN AMRO Bank, it offers an advantage that few banks can match-local support in more than 3,400 locations in more than 60 countries and territories. Anywhere your business takes you, LaSalle can meet your needs.