November 15, 2021 •CSG Partners Staff
Why are staffing, architectural, and engineering firms – as well as consultancies and other high relative payroll companies – strong ESOP candidates? CSG's Founder and Managing Partner, Lawrence Kaplan, answered this and other employee ownership-oriented questions in a recent Vistage Networks webinar.
According to the National Center for Employee Ownership, nearly 20% of all US ESOPs are sponsored by professional services companies. Accelerated income tax deductions are a major draw, but many firms also cite increased productivity, stronger corporate cultures, and employee retention advantages – especially in competitive labor markets.
The Q&A session covers a range of topics including:
- Benefits of Employee Ownership
- Why Professional Services Firms Choose ESOPs
- Comparing ESOPs and Buy-Sell Agreements
- Selling a Portion of your Company to an Employee Trust
- How Stock is Allocated and Additional Incentives Options
Selected content, in addition to the entire webinar, can be found below. Although the conversation was geared towards professional services firms and their advisors, almost all the subject matter is applicable to closely-held companies from any industry.
Our friends at Vistage have graciously made this content available to all.
Featured ESOP Questions & Answers
"An ESOP is an ERISA authorized, defined contribution plan that invests in employer securities... but you an also look at an employee stock ownership plan as a tax-advantaged leveraged buyout of your own company."
"In many cases, the primary driver for a leveraged ESOP is liquidity, but there are also tax efficiencies on multiple sides of the transaction... Professional service firms – because of the nature of their firms being high payroll entities – they are able to get better tax deductions than the average company."
"Do owners who have built these companies up – sometimes over many decades – really want to sell to a third party? It can cause significant disruptions to their companies and many employees could lose their jobs."
"For so many of these companies who are looking to continue their culture, and to continue to working in their community, the ESOP often is a better solution."
"An employee stock ownership plan can be a more tax-efficient tool than a partnership buy-sell agreement."
"In an ESOP transaction, a company can borrow money, pay-out a selling shareholder (who can then defer capital gains taxes), and the company can repay that debt using pre-tax dollars. So there's tremendous benefits all around to using an ESOP as an alternative to a buy-sell agreement amount partners or as a tool to encourage a management buyout of that company."
"The majority of transactions we complete are 30% to 49% ESOP sales. 30% is the minimum you need to sell to be eligible for the 1042 tax deferral."
"Professional services firms often start off with a minority ESOP sale. They want to see how it's going to go, see how the management team response, and see how the company responds. If things go well, the company will sell incremental pieces down the line and eventually become 100% employee-owned."
"An ESOP is a non-discriminatory plan, so every employee, so long as they've been with the company for a year or so, is going to be eligible to participate."
"Every year, shares will move to employees accounts, and the number of shares they are allocated is based on their salary, as a percentage of the total payroll."
"If you're looking to use an ESOP as a management buyout tool, you may want to incorporate other components – whether it's warrants, stock options, or stock appreciation rights – so that key managers are going to get something above and beyond.
Additional Employee Ownership Topics Covered:
- Tax Implications for LLCs, S and C Corporations
- Tax Advantages of an 100% Employee-Owned S Corp
- How Employees can Benefit from an ESOP
- Role of an ESOP Trustee
- Role of an Employee-Owned Company's Board of Directors
- ESOP Stock Vesting Schedules
- ESOP Valuations
- Securing Third-Party Financing
- Employee Ownership "Good Fits"