What are Typical Characteristics of an ESOP Candidate?
This is the third in a series of three articles discussing benefits, incentives and candidates for Employee Stock Ownership Plans. This article identifies characteristics of companies and owners that are possible candidates to consider an ESOP. The first article focused on federal tax benefits and the second article focused on Iowa and Nebraska ESOP formation incentives.
For most non-publically traded companies, if debt financing is likely to be employed in connection with an Employee Stock Ownership Plan’s ("ESOPs’") purchase of employer stock, successful ESOP candidates generally have the following characteristics:
• The company is a subchapter C or subchapter S corporation (partnerships and LLC’s do not qualify but could convert to become a corporation).
• The company is and has a sustained profit history (e.g., at least five-years of being profitable); and, the higher the tax rate, the greater the ESOP benefit.
• The company is credit worthy and has borrowing capacity.
• The company is not bound by lender covenants that restrict its ability to borrow.
• The company has annual revenue of at least $5
million - $7 million and unrestricted cash flow to service the ESOP debt.
• The company will have sufficient payroll after the exit of the selling shareholder(s) (and also excluding their spouses and children) to support annual deductible ESOP contributions.
• One or more significant shareholders is interested in selling company stock (except in the case of subchapter S-corporations, it is beneficial to a selling shareholder that the ESOP own 30% or more of the company’s outstanding stock after the shareholder’s sale).
• The company wants to buy out minority shareholders on a tax-advantaged basis.
• The company has a strong successor management team in place if current management will leave the company as a result of the sale of stock.
• The company wants to share ownership, provide incentives, and share the rewards of enterprise success with employees.
ESOPs are as different as the companies that sponsor them and the owners who sell stock to them. There is no one-size-fits-all approach or design and not all companies or shareholders are good candidates to use an ESOP. Initial steps include conducting a feasibility evaluation, obtaining a preliminary valuation, identifying possible design alternatives and securing preliminary financial commitments before proceeding with establishment of an ESOP. Further, understanding and addressing on-going operational, liquidity, regulatory, fiduciary, record-keeping, and compliance requirements are essential.
Koley Jessen P.C., L.L.O. has a long and proud history of helping companies, shareholders, lenders and fiduciaries in all phases of successful evaluation, design, implementation and on-going administration of ESOPs. Koley Jessen is a nationally recognized leader in employee benefits, fiduciary guidance, labor and tax law. Attorneys in the Firm’s Employment, Labor and Benefits Practice Group advise businesses, governments, and nonprofit/tax-exempt organizations on a wide variety of retirement plans, health and welfare benefit plans, non-qualified deferred compensation and equity based compensation arrangements.