With the increase in capital gains taxes after 2013 and strong bi-partisan support, ESOPs have increasingly been an option for owners looking to create a liquidity event while still retaining control over the culture and the business that they created.
The main benefits of ESOP’s are:
- Creating a buyer for your stock to help in most any type of business transition
- Multiple tax potential benefits—(consult with a tax specialist) deferral of capital gains taxes, deductions of both interest and principal for purchase payments, and a 100% ESOP owned company can avoid nearly all income taxes
- Incentivize employees to work with an ownership mentality. Many studies have shown a potential increase in productivity.
Negatives of an ESOP are:
- The valuation of the business is established by an independent valuation specialist—an outside buyer might pay more. This valuation is one of the most important parts of an ESOP transaction.
- While a longer term concern, the repurchase liability needs to be diligently considered.
- They can be complicated and require an experienced team. Care must be taken to assure benefits (like tax savings) outweigh costs.
It’s also important to dispel some ESOP fables:
- Fable--ESOP’s require active voting control and open financials for employees. Truth—Employees gain a beneficial interest in the stock with limited voting rights and limited annual financial information. Employees have no say in day to day operations (unless part of their job function) and do not see the salaries of their co-workers.
- Fable—ESOP’s can hurt lending/bonding capabilities. Truth—While it is important to have a banker/bonding agent who understands how an ESOP works, an ESOP by itself does not change the financial strength of a company. In fact, sometimes it can increase cash flow with the tax savings generated.
Harbour Wealth Management has experience assisting owners in evaluating, implementing and maintaining ESOP succession plans and has relationships with some of the most experienced ESOP experts in the country.