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

2. 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)

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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%

15. How ESOP’s work

16. 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

17. How It Works: Step 1
The Company
Adopts
ESOP Trust

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

19. Leveraged ESOP

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

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

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

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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

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

31. 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

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

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

34. 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

35. 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

36. 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

37. 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

38. 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%

39. 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

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

41. 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

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

43. 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

44. 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

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