June 2012 Succession Planning: The ESOP Solution Thomas Roback, Jr., CEP, QKA Managing Director Blue Ridge ESOP Associates

I. About Blue Ridge ESOP Associates

2 About Blue Ridge ESOP Associates Over 24 Years of Experience  Established in 1988 ESOP Administration Experts  ESOP Administration is Our Primary Business  One of the Top Four Firms in the US in Number of Clients and the most interactive on-line tools in the industry Professional Staff with a Focus on Outstanding Client Service  Directors and Managing Directors with 15 to 25 years of experience  Administration Staff with Professional Designations  Dedication to Providing Outstanding Client Service

II. What is an ESOP and Why Consider Putting an ESOP in Place?

4 ESOPs: A Solution for Private Business Succession At any given time, about 40% of closely-held U.S. businesses are looking for a transfer of ownership solution. Less than 1/3 of closely-held family businesses survive the transition from first to second generation ownership. Plans are unclear for CEOs who are:  Retiring in five years – 42% have no identified successor.  Age 60+/- 28% have no successor.

5 Closely-Held Clients Need Help With Ownership Transition Most hope to cash out or transfer the business to family members. In either case, your autonomy may be at risk. Brokers and M&A specialists prey on business owners with promises – which cannot always be kept. You need unbiased strategic counsel to provide integrated options and an understandable process to achieve desired continuity goals.

6 Percent of Business Owner Net Worth Age 50 Business Successful Business Outside Wealth Age 40 Business Growing Business Outside Wealth Age 65 Business Transition Outside Wealth Business Growth is TaxedTransition is Taxed And Death is Taxed

7 Reasons Why Owners Fail to Successfully Transfer Their Business Lack of viability of the business. Reluctance by owner to give up control. Reluctance of next tier management or family members to take the helm. No real buyers. Adverse tax consequences. Lack of planning, the primary cause for failure.

8 1 P RELIMINARY I NTERVIEW 2 D ISCOVERY P HASE 5 M ANAGEMENT P HASE 3 D ESIGN P HASE 4 I MPLEMENTATION P HASE Vision, Values, Goals Strategies and Products Integrated Planning Process

9 Comprehensive Planning Approach 1.Shareholder Considerations 2.Executive Benefits 3.Company Considerations 4.Employee Benefits 1.Cash Flow 2.Tax Planning 3.Wealth Management 4.Wealth Distribution 5.Personal Legacy Decisions should be made in the context of the complete picture. BUSINESS INTERESTS PERSONAL INTERESTS CREATIVE PLANNING OVERLAP

10 Options/Structures Available to Business Owners Close/liquidate the business. Gifts of stock, charitable trusts, and/or private foundation. Sell to an outsider. Sell to insiders (management, family members and/or employees).  Family limited partnership.  Installment sales to family members or rising management.  Employee Stock Ownership Plan (ESOP). Retain ownership but hire outside management and keep taking a paycheck or establish deferred compensation arrangements. A combination of the above…

11 PRIVATE CORPORATIONS These taxes are seldom addressed in an integrated fashion Corporate income taxes Personal income taxes Capital gains taxes Gift taxes Estate taxes Generation skipping taxes Taxes impacting companies, their owners, and families

12 The rising manager(s) are not usually high net worth individuals. “ OK, we ’ ll bonus her the money and she ’ ll buy our stock. ” $100,000 bonus to a rising manager – manager pays $40,000 taxes, leaving $60,000 for stock purchase. Manager buys $60,000 of stock from shareholder: shareholder pays $10,000 capital gains tax (increase after 2012?) The Vanilla Private Company Deal: Selling to Management Outcome: Government $50,000 - Owner $50,000

13 Sale of Stock to Outside Buyer Complete sale of stock to an outside purchaser. Partial sale of stock to outside purchaser  New purchaser generally will purchase enough to gain control.  Minority stockholders then have limited powers. Tax consequences of sale  Long-term capital gain treatment vs. ordinary income.

14 Sale of Stock to Corporation (Redemption) Sale must not impair capital of the corporation or cause it to become insolvent. Corporate redemption reduces the number of issued and outstanding shares (anti- dilutive): may alter control and share valuation post transaction. Tax Consequences to the selling stockholder  May qualify for capital gain treatment or may be treated as dividend. Tax consequences to the corporation  No taxable gain to the corporation unless it uses appreciated property in redemption.  Stock acquired with after-tax dollars  Interest paid on Promissory Note is generally tax-deductible.

Which approach can do all of the following?  Maintain ongoing company  Provide a competitive advantage  Allow for tax-advantaged sale by owner of all or part of the business The Answer… an ESOP! 15

A defined contribution retirement plan that is qualified under federal tax law (Sec. 401(a)) and is primarily invested in company stock. Similar rules for eligibility and vesting as other qualified plans. What is an ESOP? 16

Benefits of an ESOP  Company remains intact  Significant tax advantages  Added benefit to employees  Benefit linked to company performance 17

III. ESOP Mechanics

19 How To Create An ESOP  Conduct a Feasibility study  Hire Independent Appraiser to determine FMV for the company ’ s stock  Consult with an Attorney on ESOP plan design/fiduciary issues and preparation of trust, plan, and related documents  Hire ESOP Administration firm  Appoint the ESOP Trustee  Proceed with implementation and sale 19

Cash Contributions ESOP Loan Payments ESOP Loan Company Loan Payments Cash Common Stock SellingShareholders Company Company LoanBank Stock Allocation s / Distributions Employees QRP Leveraged Transaction - Variations ESOP Trust 20

21 Cash Contributions Cash Common Stock SellingShareholders Company Stock Allocation s / Distributions Employees Non-Leveraged Transaction ESOP Trust

IV. ESOP Tax Incentives

 Owner  Selling C Corp. shareholder(s) may defer capital gains taxes on sales of stock to an ESOP ( “ Section 1042 Rollover ” ) if reinvest in QRP within 12 months from sale.  If seller note, can use installment treatment on payments.  Can take below market interest rate in exchange for warrants.  If no section 1042 election, owner can participate in ESOP if still an employee. C ompany  Contributions to ESOP are tax-deductible (generally 25% limit, but separate 25% for other DC plan of C Corp.). Contributions to the ESOP to repay both principal and interest on ESOP loan (not just interest). C Corp. dividends paid to participants or used to pay ESOP debt deductible. C Corp. ESOP loan interest do not count toward section 404 limit  Employees  Contributions and earnings thereon to ESOP accounts are tax-deferred until distribution.  Special section 415(c) rules for C Corp. ESOPs. Forfeitures & interest on loan repayment excluded if < 1/3 ESOP contribution goes to HCEs. ESOP Tax Incentives 23

Tax Incentives continued…  Since there are no federal taxes on an ESOP ’ s share of S Corp. income, a 100% S Corp. ESOP does not need to make distributions to shareholders to pay these taxes. Enhanced cash flow! An ESOP ’ s portion of the income earned by an S Corp. is not taxable.  Downside – No section 1042 rollover permitted. However, can do deal as C Corp., then switch to an S Corp., or if S Corp. can switch to C Corp. and do deal and then change back to S Corp. after 5 years.  Separate “ anti-abuse ” testing under section 409(p) 24

25 Distributions (Repurchase Liability) Small account balances typically paid in lump sum after year of termination Other payments typically start 6 th years after termination or 1 year after retirement/ death / disability  Participant may delay distribution until age 65  Paid in cash lump sum or in annual installments up to 5 years Distributions taxed as ordinary income unless rolled over into an IRA In C Corp. leveraged transactions, distributions typically delayed until the loan is paid off

26 Current ESOP Statistics from the NCEO*  The National Center for Employee Ownership estimates that as of 12/31/11 there are about 10,900 ESOPs  There are over 10 million employee-owners  The % of ESOP companies in manufacturing has declined to about 17%  Construction (9%), and professional/scientific/technical firms (15%) have held steady through the 2000s  Finance/Insurance/Real Estate has declined to about 16%  The % of leveraged ESOPs has declined to about 32% *Employee Ownership Report, April 2012, NCEO.

27 Current Events in the ESOP World  Congressional impasse on most issues, but ESOPs are generally something both sides of the aisle can agree on  2010 General Social Survey found that only 2.6% of employee-owners reported being laid off in the previous 12 months, compared to 12.1% of non-employee- owners. Aslo, 24.3% of non-owner employees intend to lok for a new job in the near future, while only 12.9% of employee-owners do.  Georgetown Business School study showed that in the most recent recession, S Corp. ESOP companies showed resilience and performed better than other companies in providing for workers' retirement security, job creation, and revenue growth.  2010 TEA/EOF survey showed the average age of ESOPs to be 15 years and the average account balance $195k!  83 million Baby-Boomer business owners are starting to think about retirement and an ESOP could be the right solution  May see some business owners sell before 12/31/12 to lock in low 15% capital gains rate  §1042 may become more fashionable in 2013 and beyond with higher capital gains rate

Q & A