For most companies contemplating some form of seller exit, an ESOP is often discussed as an alternative strategy. Considering an ESOP today is more fraught with some anxiety than ever before. Why? The answer is the spate of recent Department of Labor court cases involving suits against trustees and companies for overinflated common stock values.
An ESOP is still a viable exit alternative. Some of the key reasons follow:
- Owners often sell minority shares at a control premium if there is a Board approved plan in place to ultimately dispose of a majority or all of the shares over a short time frame.
- Employees do not use their money to acquire the shares.
- Selling shareholders can permanently defer capital gains taxes if they elect IRC 1042 treatment (investment of the proceeds into a public entity).
- Selling shareholders may retain post-closing control of the business or vest control in a selected management team.
- Sellers often seller-finance a portion of the purchase price, especially to fill the void when bank credit is lacking. This seller financing is at a market level return, usually plus warrants.
- Company gets full tax deduction of interest and principal for outside institution debt financing the purchase.
- Employee interests and success are aligned with company. Retiring or departing employees redeem their earned shares for cash.