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Transcript
The ESOP Concept:
Is Your Trucking Company a Good Candidate?
April 24, 2017
Mark A. Flinchum, CPA
The information presented herein is general in nature and
should not be acted upon without the advice of a professional.
© 2017 KSM Business Services, Inc.
Agenda
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▪
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▪
The ESOP Opportunity
The ESOP Structure and Operation
ESOP Advantages and Disadvantages
ESOP Profile and Third Party Buyout Comparisons
Next Steps for Interested Companies
Questions
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The ESOP Opportunity
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What is an ESOP?
▪ Tax-qualified retirement plan
▪ Operates similar to a profit sharing or 401(k) plan
▪ Investment primarily in employer stock
▪ Used as a corporate finance and business succession
tool
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Why an ESOP?
▪ ESOP purchases the business with tax deductible
dollars
▪ In properly structured sale, the seller of C corporation
shares pays no capital gain on the sale
▪ Employees are incentivized to grow the company
▪ 100% ESOP-owned company can operate generally
tax-free
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Alternative to Sale to Strategic Buyer
▪ Control over timing of sale
▪ Greater job security for current employees
▪ Maintain independence of company
▪ Flexibility to quickly react to opportunities and
challenges in the marketplace
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The ESOP
Structure and Operation
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Typical Leveraged ESOP Structure
cash
1
outside loan 6
cash
inside loan
5
2
stock
4
cash
3
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Post-Transaction Cash Flows
1 retirement contribution
loan re-payment 2
3
4
shares released
loan re-payment
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Ownership
▪ ESOP Trust is stockholder of record
▪ Beneficial ownership on behalf of plan beneficiaries
(the employees)
▪ Trustee of the ESOP must be named
▫ External Trustee (bank) or Internal Trustee
▫ Takes on fiduciary responsibility
▪ ESOP does not have to own 100% of Company’s
stock
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Plan
▪ Complexity of drafting ESOP plan requires
experienced ERISA legal counsel
▪ Terms that most impact ESOP participants:
▫ Plan eligibility (ex. one year from start of employment)
▫ Vesting of contributions (three yr. Cliff / five yr. Step)
▫ Payment of balance upon retirement (ex. within first year,
except in cases of large balances)
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ESOP Advantages and Disadvantages
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ESOP Advantages - Seller
▪ To the Seller
▫
▫
▫
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Seller may retain a portion of equity
Known Buyer/Exit Strategy
Diversify Seller’s Net Worth
Section 1042 Rollover
- Benefit available to seller of C-Corporation stock
- Defer Capital Gains on Stock Sale
- Eliminate Capital Gains (step-up basis, if assets held at death)
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ESOP Advantages - Company
▪ To the ESOP Company
▫ Use pre-tax cash flow to repay indebtedness (ESOP contribution
is tax deductible, use contribution to repay loan)
▫
▫
▫
▫
▫
▫
Enables faster repayment of debt with improved cash flow
Can be used as a financing device
Avoid using after-tax dollars to redeem owner’s shares
Retention of motivated employees
Continuity of management
Higher Sales, Job Retention - ESOPs increase sales, employment, and
sales/employee by about 2.3% to 2.4% per year over what would have been
expected absent an ESOP (Rutgers/2000)
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S-Corporation ESOP Tax Advantage
▪ Compelling S-Corp ESOP Advantage
▫ Earnings inside your 401(k)/retirement plans are not taxed
until you take distribution
▫ ESOP is an ERISA plan just like 401(k)
▫ Therefore, S-Corp ESOP’s earnings are not taxable in the
current period. They are only taxed when participants take
distribution upon death, disability, retirement, etc.
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ESOP Advantages - Employees
▪ To Employees
▫ Employees participate in the appreciation of the company’s value
▫ Avoid sale to a third party which could affect jobs
▫ Avoid potential loss of jobs during economic downturns - 3% of
employees with employee stock ownership were laid off during Great Recession
compared to a 12% rate for employees without employee stock ownership (National
Science Foundation & GSS/2012)
▫ Increased job satisfaction
▫ Exit strategy (put right)
▫ More Retirement Assets - ESOP participants have approximately 2.2 times as
much in their accounts as participants in comparable non-ESOP companies with
Defined Contribution plans (EOF/2010)
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ESOP Disadvantages
▪ ESOP can only pay Fair Market Value
▫ Strategic premium might be gained by sale to industry
participant or ‘roll-up’ buyer
▪ Owners may not get 100% ‘cash out’
▫ Even with high leverage, a 100% sale will require taking back
a “seller note” for a portion of the sale price
▪ Complexity of ESOP and regulation
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C-Corporation Planning
▪ C-Corporations selling stock to ESOP are eligible for
Section 1042 capital gain deferral
▪ To qualify for Section 1042, ESOP must:
1. Own at least 30% of company after the sale
2. Seller must have held the stock for at least three years
3. Seller must purchase securities defined as “Qualified
Replacement Property” (QRP)
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C-Corporation Planning (continued)
▪ If a selling shareholder elects Section 1042 treatment, the
shareholder (and family members) may not participate in the
ESOP Plan for the latter of 10 years, or the payoff of the
acquisition debt (“Inside Loan”)
▪ Capital gains tax of 20% still historically low. Consider evaluate
paying tax and not deferring under Section 1042 depending on
facts and plans
▪ If forming or increasing ESOP ownership to 100% may want to
consider accelerated plan funding to create tax NOLs tax
deductions
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ESOP Profile and
Third Party Buyout Comparisons
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ESOP Candidate Profile


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
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Owner approaching retirement
Capable management team to succeed owner
Unused debt capacity
Profits to support ESOP debt service
Company size (more cost effective benefit)
Motivated by tax advantages
Motivated by “ownership culture” advantages
Desire to buy-out a minority shareholder
Limited third party / strategic buyers in market
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ESOP vs. Third Party Buyout
ESOP
Third Party Buyout
Company controls timing
Buyer controls timing
Price base upon independent
valuation
Strategic buyers may pay
“synergistic” premium
Payment depends upon company’s
borrowing capacity
Buyer’s more likely to arrange own
financing
Seller financing can be used to
improve purchase price
Purchase price more likely to consist
of stock, or include earn out features
ESOP structure more likely to
preserve jobs
More likely to result in layoffs and
downsizing
ESOP structure is an incentive to all
employees to increase profitability
Generally fewer incentives to rank
and file employees
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ESOP vs. Third Party Buyout
ESOP
Third Party Buyout
Smaller companies tend to be more
nimble in a highly competitive
environment
As part of a larger organization, there
is less flexibility to quickly react to
changing conditions
Depends upon company’s borrowing
capacity
Greater ability to infuse capital for
expansion and acquisitions
More flexibility to sell part of the
company and for sellers to retain
growth potential
Aside from earn out provisions,
buyers tend to purchase substantially
all of the company
Executive potential for participation is
restricted only by their ability to grow
the company
Executives tend to be restricted by
company policies and practices
regarding incentives
ESOP purchases company stock
including existing liabilities
Generally purchase assets leaving
shareholders with existing liabilities
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Next Steps for
Interested Companies
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From Ideas to Actions
▪ Will an ESOP help us
achieve the varying
objectives?
▪
▪
▪
▪
25
Board
Shareholders
Management
Employees
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ESOP Feasibility Analysis
▪ A Feasibility Study will allow corporate decision makers
to determine if, and to what extent, an ESOP can assist
the board, management and shareholders in achieving
desired objectives
- Smiley, et. al., “Employee Stock Ownership Plans”
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ESOP Feasibility Analysis
▪ What is included:
▫
▫
▫
▫
Valuation Analysis
Deal Structure discussion & analysis
Financing options & alternatives
Potential for §1042 Rollover
Circumstances may lead to creating two or more Scenarios
* 30% Transaction vs. 100% Transaction
* Bank Financing vs. Seller Financing
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Stage 1: Planning & Analysis
Information Gathering
Establish Objectives
Feasibility Analysis on alternatives that
might meet established objectives
ESOP
Third Party
Sale
Family
Succession
Review Findings and Conclusions
Decision
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ESOP Deal Team
Sell Side
(Shareholder(s))
• Valuation Advisor
• Shareholder Counsel
• Same as Company Counsel?
• CPA/Tax Advisor
Buy Side
(Trustee)
• Valuation Advisor
• Trustee Counsel
• Plan Administration (TPA)
Company
• Management
• Company Counsel
• Bank
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Stage 2: ESOP Formation
Build ESOP Deal Team
Complete Corporate Restructuring
(if needed)
Raise Capital for Transaction
(Bank / Private Equity / Employees)
Financing
Draft
ESOP
Plan
Valuation
Opinion
Transaction
Doc’s
Trustee Deal Review, Approval
Close Transaction
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Questions?
Mark Flinchum
P 317.580.2018
E [email protected]
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