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SHELDRICK, MCGEHEE & KOHLER

ESOPs

An Employee Stock Ownership Plan (ESOP) is a profit sharing-type plan, qualified under ERISA, whereby periodic payroll contributions are made to purchase shares of the company’s stock on behalf of the employees. These plans have been in existence since the mid-1970s and more than 10,000 companies throughout the U.S. have active ESOPs involving an estimated eleven million workers.

The intention of the original ESOP legislation was to provide a mechanism by which private business owners could sell shares of their company to their employees within the context of a qualified employee benefit plan. This is done through the establishment of an ESOP Trust, an entity created to hold company shares for the benefit of the employees. For private companies the Trust generally purchases shares, on behalf of the employee participants, from existing shareholders of the company who wish to liquidate either part or all of their ownership interest. In that the ESOP is structured as a qualified plan, all of the contributions are deductible for federal tax purposes making the ESOP a very tax efficient vehicle for acquiring company shares. Another tax benefit is that, under certain circumstances, the selling shareholder(s) can defer the capital gains tax when selling their shares to the ESOP.

It is our opinion that ESOPs are best suited for established companies that are consistently profitable, have active professional management (both owner and non-owner managers), have a perceptible market share in their given business, have growth potential and, ideally, have a culture of shared management responsibility. Generally it takes three to six months to set the plan up and experienced professionals can make this a smooth and efficient process.

Typically the progression requires the creation of a Trust and naming a Plan Trustee (initially this can be, and usually is, the current business owner), a Legal Advisor, a Plan Administrator, and a Financial Advisor to provide an initial and ongoing annual valuation of the company. It is vitally important for new ESOP candidates to assemble a team of experienced professionals in order to ensure that the Plan is properly designed consistent with the goals and objectives of each company and its ownership.

The employees do not directly own shares in company stock. The shares are allocated on an annual basis (in some cases more often) to the ESOP Trust for the benefit of each participating employee based on an individual’s length of service and compensation level. Typically, payment for the shares is made through annual employer contributions. The Trustee is charged with ensuring that the Plan is properly administered and that the financial advisor provides the Trustee with an opinion of share values on an annual basis (in some cases more often) which in turn is used to allocate shares to each participant's account.

For business owners and/or their advisors who are considering an ESOP, there is information available from The ESOP Association in Washington, D.C., and also from the National Center for Employee Ownership (NCEO) in San Francisco, California. Our firm often serves as a “sounding board” for business owners and advisors who are considering implementing an ESOP. SMK has been involved with over 200 plans, currently serving over 90 employee ownership companies annually, and is active in professional ESOP associations. Based on our lengthy experience, we are able to discuss the general attributes of an ESOP and its advantages and disadvantages for a particular company/owner. In summary, ESOPs were created to provide a tax efficient way for private business owners to sell all or part of their companies to their employees, particularly for those business owners who are so inclined to do so. For many business owners ESOPs are an attractive exit strategy, but for certain types of companies the ESOP concept may not work at all.

The first step, even if the concept of the ESOP is just being discussed, is to determine whether a given company is in fact a realistic candidate for an ESOP. Below is a link to an analysis our firm prepared discussing preferred characteristics for companies considering an ESOP. This write-up summarizes our various experiences and perceptions with ESOPs, discusses various guidelines and parameters that should be considered in the process, and will give you an indication as to whether your company is a viable ESOP candidate. We encourage professional advisors and business owners who are considering ESOPs to call us, and we will be glad to discuss this information with them.

Please feel free to call us anytime at 904.355.4715.

Richard E. Kohler

Steven M. Rosenbloom


Characteristics of ESOP Companies

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