ESOP

An Employee Stock Ownership Plan (ESOP) is a type of qualified retirement plan often used as a business succession or liquidity strategy.  As the name implies, ESOPs offer employees the opportunity to become owners of their company by having shares of stock allocated to their accounts in a tax-qualified trust.  Tax incentives available only to those selling their interest to an ESOP trust, and to companies owned in part or in whole by an ESOP, enhance the benefit of this transaction to both the company and the selling shareholder. This can be a very effective estate planning tool; creating liquidity and business succession planning that enhance both sides of the transaction.

By having control over how much of the business is sold to the ESOP and when, the seller maintains control over their exit strategy and has created a buyer for the stock that does not exist today. The Internal Revenue Code can include the option to defer, (and with proper planning potentially eliminate), the capital gain on the sale of the shares to the ESOP trust, and the shares within the trust grow on a tax deferred basis, enhancing liquidity for both shareholders and employees.

ESOP 101 Brochure
 

Disclosures:

This information has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of May 2017.

Since each investor’s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

Wells Fargo Advisors is a trade name used by Wells Fargo clearing Services, LLC, member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.
An ESOP purchases shares from existing shareholders and allocates those shares to ESOP participants’ accounts over time, giving employees ownership in the company.  An ESOP may purchase shares from the existing shareholder in a number of ways. If the company has enough cash on hand, it may lend that cash to the ESOP trust, which will then buy the shares with that money. Most of the time, leverage is needed to generate the capital required to buy the shares. A bank familiar with leveraged ESOP transactions can provide all or some of that up front lending. In addition to bank lending, either mezzanine lending or seller financing may also be used as a secondary source for liquidity to facilitate the transaction.

In a leveraged transaction, cash is lent to the company, in the form of an outside loan. The company then lends those same funds to the ESOP trust, known as the inside loan. The trust in turn gives that cash to the selling shareholder in exchange for the shares of stock. On the day of the transaction, the value of the shares of stock in the trust and the amount of the inside loan to the stock are equal. Over time, as the internal loan is paid down, shares are allocated within the trust to employee accounts based upon compensation and years in the plan.

Please see page 5 of The ESOP Opportunity for an illustration of this transaction.

ESOP Brochure
 

Disclosures:

This information has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of May 2017.

Since each investor’s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

Wells Fargo Advisors is a trade name used by Wells Fargo clearing Services, LLC, member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.
Under IRC Section 1042, a selling shareholder may roll the cost basis from their company shares sold to the ESOP into a commensurate investment if the transaction meets certain requirements. Much like IRC Sections 1031 and 1035 with real property and insurance policies, a 1042 transaction is a type of like/kind exchange.  The shareholder may replace their current holdings, (stock in a U.S. domiciled operating business), with stocks or bonds of a U.S. domiciled operating business. The property they choose must meet certain requirements and must meet the IRS standard for a Qualified Replacement Property (QRP), under the statute. Unlike Sections 1031 or 1035, Section 1042 only provides one opportunity for purchase of the QRP. Once those elections have been filed with the IRS, if those securities are ever sold, called, or mature, it will trigger the capital gain on that pro rata portion of the QRP portfolio at the then capital gains rate.

Our team specializes in helping to build out a proper QRP portfolio that not only meets the requirements but can ultimately outlive the selling shareholder, allowing for a step up in tax basis upon death and a permanent deferral of the capital gain. We would be happy to discuss the nuances of this transaction further as it is a complex investment strategy and should be done only by those with experience specifically regarding Section 1042.

Please refer to our piece “ESOP: IRC Section 1042 Transaction”.

1042 Whitepaper
 

Disclosures:

This information has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of May 2017.

Since each investor’s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

Wells Fargo Advisors is a trade name used by Wells Fargo clearing Services, LLC, member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.
There are several advantages and disadvantages in deciding to implement an ESOP plan. They include the following and more which we can discuss at length when you are analyzing this option.

Advantages of implementing an ESOP plan to own the business go beyond the wealth that is generated from a transaction. The ongoing tax benefits, in the instance where a company is an S corporation, (ESOP owned S-corps are not subject to corporate tax), greatly enhance the ability of the business to pay down the ESOP debt post-transaction, and can give them an ongoing operating advantage over their fully-taxed competitors. In addition, when properly communicated, an ESOP should create an espirit de corps, meaning an enhanced sense of satisfaction and pride in the employees who now own part of the business. Studies have shown time and again that ESOP companies generally have lower turnover, higher productivity, and weather the storm better than their non-ESOP brethren.

Disadvantages of selling to an ESOP are also some of the reasons that a seller may choose, after careful consideration, not to do an ESOP transaction. They may include valuation and other issues. An ESOP must pay fair value for the shares; it will not pay a discounted price and it cannot get into a bidding war with an outside buyer. Also, if it is a leveraged transaction, that debt may create too much leverage for a business dependent upon leverage to grow or operate. It may not be feasible to take on the debt required to buy out the selling shareholder.

ESOP 101
 

Disclosures:

This information has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of May 2017.

Since each investor’s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

Wells Fargo Advisors is a trade name used by Wells Fargo clearing Services, LLC, member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.
Our team has helped educate internal and external partners, prospects and clients for over 20 years, providing an overview or a deeper dive into the many considerations before, during and after an ESOP transaction. We work closely with your attorney, accountant and other advisors to help determine whether an ESOP makes sense for your company and how it can best be implemented. We believe the better everyone understands the transaction and the objectives of the selling shareholder, the greater the satisfaction upon completion.

The National ESOP advisory team at Wells Fargo includes team members across different business lines within our organization. We provide clients with access to other lines of business within Wells Fargo, including Wells Fargo Commercial Bank and Wells Fargo Private Bank*, to provide comprehensive support throughout the transaction as much as possible. It is our goal to help simplify the process and provide guidance and resources whenever we can.

*Wells Fargo Private Bank provides products and services through Wells Fargo Bank, N.A. and its various affiliates and subsidiaries. Well Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

ESOP Brochure
 

Disclosures:

This information has been prepared for informational purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The accuracy and completeness of this information is not guaranteed and is subject to change. It is based on current tax information and legislation as of May 2017.

Since each investor’s situation is unique you need to review your specific investment objectives, risk tolerance and liquidity needs with your financial professional(s) before a suitable investment strategy can be selected. Also, since Wells Fargo Advisors does not provide tax or legal advice, investors need to consult with their own tax and legal advisors before taking any action that may have tax or legal consequences.

Wells Fargo Advisors is a trade name used by Wells Fargo clearing Services, LLC, member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.