Employee Stock Ownership Plans (ESOPs) 101 Presented by: Roy Farmer

Business Transition Advisors, Inc. Full Service Business Transition Services Employee Stock Ownership Plans (ESOPs) Non-Leveraged Leveraged Corporate reorganizations Corporate refinances Company stock redemptions Leveraged mgmt/partner buyouts Third party/Private equity sales (affiliates)

Business Transition Advisors - ESOP Full Service ESOP Implementation Services Preliminary Analysis Feasibility Studies Plan and Transaction Design Financing Repurchase Liability Studies Employee Communications Post Transactional Services

What is an ESOP? An ESOP stands for an Employee Stock Ownership Plan A tax qualified defined contribution employee retirement plan Qualifies under IRC Section 401(a) and Section 4975(e)(7) Overseen by the IRS and the Department of Labor

ESOP Statistics Modern ESOPs came into being with passage of ERISA-1974 10,000 ESOP companies in America today Almost 1 Trillion in Assets Held This includes large and small Companies 21% of all U.S. private sector workers own company stock Wal-Mart, Lowes, Charles Schwab, Southwest Airlines, Morgan Stanley, Motorola, Publix

Unique Features Must invest primarily in employer stock Can use borrowed funds (leverage) No employee contributions generally allowed Stock sold to ESOPs can qualify to defer capital gains tax – certain rules apply Contributions can vary year to year, unless borrowed funds are used

Uses of ESOPs Business Owner Exit Strategy/Next Generation Transfer Liquidity/Diversification for Closely Held Stock Partner Buy Out Desire for Employee Owned Culture Divorces/Immediate Cash Needs Enhanced Employee Benefits/Handcuffs Mergers & Acquisitions

Owner Transition Concerns Plan “transition” while alive and healthy Leave with competent future leadership Minimize personal and corporate taxes Leave corporation with proper working capital and manageable, if any, debt Asset liquidity and diversification Convert business to retirement income Preserve family/community legacy Exit with the most after-tax dollars possible

Transition Options Samples The following slides show a hypothetical business worth 10-million dollars, selling 60% based on the following methods: Corporate Stock Redemption Management Leveraged Buy-Out Third Party Sale ESOP

Corporate Redemption Company value $10,000,000 Value of 60% majority stock sale $6,000,000 Corp. profits needed to net sale price Corp. income tax at 40% (35% + 5%) $4,000,000 Net corp. profits available for stock purchase Sale proceeds to seller Capital gains tax at 29.2% (fed. & avg. state) $1,752,000 Net sale proceeds to seller $4,248,000 Total Taxes/Fees $5,752,000

Management Buy-Out Company value $10,000,000 Value of 60% majority stock sale $6,000,000 Bonus to execs’ needed to net sale price $9,740,000 Exec’s personal income tax 39.4% (35% + 5.4%) $3,740,000 Net corp. profits available for stock purchase Sale proceeds to seller Capital gains tax at 29.2% (fed. & avg. state) $1,752,000 Net sale proceeds to seller $4,248,000 Total Taxes $5,492,000

Third Party Sale (Stock) Company value $10,000,000 Value of 60% majority stock sale $6,000,000 Pre-fee proceeds to seller Typical sale transaction fee at 8% $480,000 Gross proceeds to seller $5,520,000 Capital gains tax at 29.2% (fed. & avg. state) $1,752,000 Net sales proceeds to seller $3,768,000 Total taxes & fees $2,232,000

ESOP Sale: C Corp Company value $10,000,000 Value of 60% majority sale $6,000,000 Pre-fee proceeds to seller Typical transaction fee at 2.5% $150,000 Gross proceeds to seller $5,850,000 Capital gains tax at 29.2% (fed. & avg. state) $0 Net proceeds to seller Total fees & taxes

Percent of Total to Seller Method “Net” to Seller Total Taxes & Fees Percent of Total to Seller Corporate Redemption $4,248,000 $5,752,000 42% Management Buy-Out $5,492,000 44% Third Party Sale (Stock) $3,768,000 $2,232,000 63% ESOP – C Corp $5,850,000 $150,000 98%

How ESOP’s work

Non-Leveraged ESOP ESOPs can be leveraged or non-leveraged A non-leveraged ESOP allows the corporation to enjoy current corporate income tax deductions by contributing either cash or treasury stock to the ESOP Cash contributions are used to buy stock from selling shareholders At the time of the actual stock sale, the seller may still take advantage of all of the traditional ESOP advantages

How It Works: Step 1 The Company Adopts ESOP Trust

How It Works: Step 2 Company ESOP Trust Selling Shareholders B U T I O N Stock or Cash ESOP Trust Selling Shareholders Buys Shares

Leveraged ESOP

How an ESOP Works: Step 1 The Company Adopts ESOP Trust

How an ESOP Works: Step 2 Lender Company Loan Loan ESOP Trust

How an ESOP Works: Step 3 Lender Company IRC § 1042 ESOP Trust Loan Loan Cash ESOP Trust Selling Shareholder Stock Cash

How an ESOP Works: Step 4 Lender Company IRC § 1042 ESOP Trust Loan Payment Loan Cash Payment Cash ESOP Trust Selling Shareholder Stock Cash

How an ESOP Works: Step 5 Lender Company IRC § 1042 ESOP Trust Loan Payment Loan Cash Payment Cash ESOP Trust Selling Shareholder Stock Cash Employees Beneficial Ownership

How an ESOP Works: Step 6 Lender Company IRC § 1042 ESOP Trust Loan Payment Loan Cash Payment Cash Cash ESOP Trust Selling Shareholder Stock Cash Interest Sinking Fund Employees Death, Disability, Retirement, Termination and Diversification

IRC § 1042 Tax Deferral Selling shareholder may elect to indefinitely defer all capital gains on sale proceeds regardless of basis Similar to real estate provision IRC § 1031 and life insurance IRC § 1035 Requirements set at a relatively “low bar” Financial products specifically made to facilitate liquidity of IRC §1042 assets

IRC § 1042 Requirements Must be a “C” Corporation ESOP must own minimum of 30% of outstanding stock post-transaction Shareholder must have owned stock for minimum of three years Shareholder must purchase Qualifying Replacement Property (QRP) within 12 months of transaction

Qualified Replacement Property (QRP) Eligible Ineligible Common Stock Municipal Bonds Convertible Bonds US Govt. Bonds Corporate Fixed Rate Bonds Mutual Funds Corporate Floating Rate Notes Foreign Securities REITs, Bank CDs Note: Eligible issuer must have 50% of its assets used in the active conduct of trade or business and no more than 25% of its gross income from passive sources

Leveraged QRP Strategy Proceeds From Sale (1042) Portfolio Floating Rate Notes Cash Balance Income with Interest Margin Account QRP can be margined to 90% Liquid Cash

Leveraged QRP Strategy Proceeds From Margin Loan New Home Cars Boat Stocks Bonds

IF YOU CONTROL THE BOARD OF DIRECTORS YOU CONTROL THE COMPANY Corporate Governance IF YOU CONTROL THE BOARD OF DIRECTORS YOU CONTROL THE COMPANY Corporate control Shareholders Elect the Board of Directors Board of Directors appoints the Officers Officers responsible for day-to-day operations

ESOP Corporate Governance (Privately Held Company) In An ESOP Board of Directors appoints the ESOP Trustee The Trustee votes the stock

Control Can Remain “Undisturbed” Owners with stock outside the ESOP Board of Directors “Directed” Trustee Votes Appoints

ESOP Employee Interest The “Directed” trustee votes the stock on behalf of the employees The employees only have a beneficial interest in the ESOP trust Employees “advise” trustee only on Mergers, Sale, Recapitalization or Liquidation Employees are not shareholders and do not have Statutory Minority Shareholder Rights

100% “S” Corporation ESOP Pays no Federal or State corporate income tax to the extent ESOP owned Taxation is “passed through” to shareholders in proportion to ownership An ESOP is tax exempt, therefore no tax is paid on percentage owned by the ESOP Corp does not have to distribute income Exempt from prohibited transaction rules

Qualitative Benefits “Golden Handcuffs” for key People Reduced Turnover Reduced Worker Comp Claims Greater Productivity Greater Profitability Greater Commitment to the Company Better Work Environment

Legacy Full Circle Many owners wanted their family and/or key management to have business but: The owner could not afford to give the business to them Family and/or key management could not afford to buy the business As shares are repurchased and retired into treasury, the percentage of ownership of outside shares increases In theory, when the last participant share is retired into treasury, any outside shares represent 100% of the company value

Legacy Full Circle: Example Shares Retired Total Outstanding Inside ESOP Owned Outside ESOP (Family/Mgmt) Percentage 100 90 10 10% 20 80 70 13% 60 50 17% 40 30 25% 50% 100%

Summary of Tax Benefits Deferral and/or Avoidance of Capital Gains Taxes on the Sale of Stock Deduction of the Full “Fair Market Value” of the Stock Purchased by the ESOP Possibility of becoming “Tax Free” as a 100% “S” Corporation ESOP

WIN-Win-Win For Everyone Business owners Employees Corporations That are more advantageous than any other single vehicle

ESOP Prospect Profile Owner wishing to cash out all or portion of business Payroll of $800,000 or greater Strong Succession Management $3,000,000 or more business value 15 + Employees or more Low cost basis

BTA’s Role Next Steps: Preliminary analysis Presentation to the client Sufficient information to determine direction Move to full implementation

BTA’s ESOP Implementation Process Educational “ESOPs 101” Presentation Initial Review of Financials & Fact Finder Preliminary Valuation Preliminary ESOP Analysis Investigative Phase Part 1 Additional Data Gathering Feasibility Study Final Client Approval to Proceed to Next Step Investigative Phase Part 2 ERISA Plan Design Transaction Design Engage Other Team Members Financing IRC§ 1042 Analysis & Execution Implementation Phase Employee Communications Management Incentive Plans Repurchase Liability & Funding Advanced Planning Determination Letter Post Closing Phase Team Quarterback Through Entire Process

Team Approach BTA Team Leader *Outside service provider Plan Design ERISA Counsel * Estate Planning Stock Valuation* Employee Communication Company CPA * Repurchase Obligation Corporate Counsel TPA* Trustee* Banker Insurance Investments* *Outside service provider

Roy Farmer Managing Director (208) 761-3612 rfarmer@bta.us.com Contact Information Roy Farmer Managing Director (208) 761-3612 rfarmer@bta.us.com