Corporations use employee stock ownership plans to accomplish a lot of different things.
Employee motivation, capital financing, even protection from a takeover–a carefully structured ESOP has the ability to do it all.
But ESOPs also have considerable value in facilitating the exit of the company owner or a key shareholder. For tax advantages and other reasons, ESOPs are an attractive strategy for helping owners fade away into that good night, confident that their business will continue to survive without them at the helm.
In a typical retirement scenario, the corporation repurchases the owners shares in the company or the owner sells his shares to another corporate interest. The proceeds of the sale are taxed as ordinary income. (If special circumstances apply, they could be taxed as capital gains.) Faced with few options, it's not uncommon for owners to be forced to sell the company they love to a competitor or liquidated at the time of their exit.
Employee stock ownership plans create more options and more benefits for individuals who own a majority share in the business. Here's what you need to know if an ESOP sounds like a viable alternative for you and your company.
- ESOPs create an instant equity market. Owners sometimes find it difficult to identify qualified buyers for their companies. An ESOP creates a market for the owner's interest from its employee base.
- ESOPs offer job security for employees. The exit of an individual with a key ownership interest is stressful for workers who are uncertain about their future employment with the company. An ESOP assuages their fears by providing an avenue for them to assume an ownership share in the business.
- ESOPs neutralize tax consequences. There is no taxable gain on the sale of stock to an employee stock ownership plan. If a retiring owner sells his stock to an ESOP so that: (1) The ESOP owns at least 30% of company stock post-sale and (2) the sales proceeds are reinvested in qualified securities within 15 months, then the sale is non-taxable.
- ESOPs can benefit the corporation. If the owner's buyout is combined with a leveraged ESOP, both the principal and interest payments of the buyout amount are untaxed. When compared to the tax consequences of direct financing routes, this benefit gives the corporation a significant incentive to borrow through their ESOP.