1. Is an ESOP right for you, and your Company?
Presented by
ESOP Services, Inc.
© ESOP Services Inc. 2019

2. What if the shareholders could…
Sell some, or all shares, at fair market value
Pay no capital gains tax
Preserve company legacy and independence
Incentivize leadership with equity or equity based incentives
Provide a meaningful retirement plan with value based on growth of company
Focus everyone on same objective: to grow shareholder value
Position the company to avoid paying additional federal and state income taxes
*Most states mirror federal law

3. Agenda Why transition with ESOPs? What is an ESOP ? Transaction design
Tax advantages
The ESOP’s impact on cash flow
What does an ESOP mean to
Corporate governance
Leadership and management
How do you set up an ESOP?
Process and Team
Next Steps

4. Why ESOPs? Liquidity in part or whole
Converting shares into cash at a fair market value, enabling the business owner(s) to diversify their portfolios
Perpetuation
Selling shareholders stay involved, if desired
Maximum tax efficiency
Shareholders, company, employees
Broadened ownership
Employees incentivized to “think like owners”
Strategic planning
Achieve shareholder and corporate objectives

5. An ESOP is a transition alternative
Answers the question, “What are my alternatives for business perpetuation and creating liquidity?”
Sale to third party
Merger
Sale to management
Corporate stock redemption
Initial public offering
Gift or other transfer to heirs
Wind up business and liquidate
Leveraged recapitalization
Sale to Employee Stock Ownership Trust (potentially tax deferred with “tax-free” dollars)

6. Over a 100 Studies ESOP Companies are: More productive More profitable
Have higher survival rates
Resources
esopservices.com
esopassociation.org
nceo.org
esopinfo.org

7. Direct Shareholders (if < 100%)
Ownership – Transfer 1%-100% of the company
Post-sale
Prior to sale
Direct Shareholders (if < 100%)
Company
Shareholder 1
Shareholder 2
Shareholder 3
Company
ESOP
Participant
Employee Stock Ownership Plan
Eligible employees become ESOP participants

8. What is an ESOP? It is a retirement plan
Designed to hold primarily stock of the sponsoring company
The company, selling shareholders, and employee participants may receive various tax benefits
The US government has given the company tax breaks for funding ESOP
The plan is regulated by the government (IRS and DOL)

9. An ESOP is a:
Buyer
Think of the ESOP as a shareholder, or any other sophisticated buyer
Can borrow to buy stock
Wants a good deal
Benefit plan
Established for the benefit of the participants, governed by ERISA
Has a trustee, appointed by the board
Tool of corporate finance
Liquidity plan and benefit plan often largely funded with tax savings

10. Leveraged ESOPs Most ESOPs are leveraged
The ESOP receives a loan to purchase a block of stock
This stock is held in trust and released into employee accounts at a rate corresponding to debt amortization

11. Financing Alternatives
ESOPs typically acquire a block of stock with leverage (“debt”) funded by one or a combination of:
Bank(s)
Excess company cash
Private equity group (PEG)
Selling shareholder(s)
Combination of the above (typical)
Management investment (rare)
Broad-based employee investment (rare)

12. Leveraged ESOP (bank and seller debt)
(2) loan to ESOP
Leveraged ESOP (bank and seller debt)
(1) Bank lends to company
(2) Company lends to ESOP
(3) ESOP buys stock from existing shareholders with cash and a promissory note
(4) Shares are held in suspense account
(5) Company makes annual tax-deductible contributions to ESOP to repay seller and bank debt
(6) Shares are released from suspense account and allocated each year as ESOP repays loans
(7) The ESOP then repays sellers and company. Company makes periodic payments to bank.
(8) Employees receive stock or cash when they retire or leave (vesting applies)
Bank
Company
(7) Periodic Payments
1) ESOP Term Loan from Bank
(7) Repay ESOP Loan
(5) Contributions
Selling
Shareholder(s)
(3) ESOP pays cash and
(4) Suspense
ESOP Trust
(3) ESOP issues promissory note
6) Allocated shares
(3) Shares move to suspense
6) Allocated Shares
Participant
Account
6) Allocated Shares
(7) Payments on promissory note
Participant
Account
Participant
Account
(8) Retirement $$
$$$

13. How is stock price determined?
By law the ESOP may not pay more than fair market value as determined by an independent valuation firm and trustee
Company’s stock price will be determined upon purchase (and at least annually thereafter) by the ESOP’s trustee, based on an independent valuation firm’s determination of fair market value
ESOP trustee
Expertise in ESOP trustee services
Appointed to act on behalf of ESOP participants
Independent valuation firm
Independent and experienced in valuation
Utilize expertise, experience, industry standards, and guidelines provided by IRS

14. Valuation Approaches Market approach Income approach Asset approach
Standard ESOP discounts
Marketability 5-10%
Minority 10-15%

15. An ESOP offers significant Tax advantages to the sellers, the Company, and the employees
Tax-deferred sale - C corporation stock [IRC 1042]
Tax-deductible C corporation dividends [IRC § 404(k)]
Tax-deductible principal repayment [IRC 404(a)(9)]
Tax-free S corporation income [IRC 409(p) and 512(a)]
Contributions may be reimbursable under federal government contracts
Participants are not taxed until distribution

16. IRC 1042 Tax Deferred Sale Seller Proceeds Illustration
Asset Sale
Stock Sale (non-ESOP)
Stock Sale ESOP with IRC 1042
Sale Price
$10,000,000
Less: Basis assumed $0
Gain on Stock Sale
Ordinary Tax On Gain (21% Fed, 5% State)*
26%
2,600,000
Capital Gain Tax Rate (20% Fed, 5% State)*
25%
1,850,000
2,500,000
After Tax Sale Proceeds
$5,550,000
$7,500,000
Paige
This example is for illustrative purposes only. Additional taxes may apply.

17. C corporation IRC 1042 “Tax-Free” rollover
Seller must have owned stock for at least three years prior to sale:
Cannot have acquired the stock in a compensatory stock option plan, or any other section 83 transaction, nor from a qualified retirement plan
Seller, certain related individuals, and greater-than-25% owners generally cannot participate in ESOP allocations
10% excise tax applies if ESOP disposes of stock within three years, except for normal benefit distribution
Above rules do not apply if company does not allow for the “tax-free” rollover

18. Qualified Replacement Property General Guidelines*
Eligible**
Common stock
Convertible bonds
Corporate fixed rate bonds
Corporate “Floating Rate Notes”
Not Eligible
Municipal bonds
U.S. government bonds
Mutual funds
Foreign securities
REITs
Bank CDs
* QRP must be evaluated by an experienced investment advisor to ensure compliance guidelines are met.
* *Eligible issuer must have:
More than 50% of its assets used in the active conduct of a trade or business
No more than 25% of its gross income from passive sources

19. The ESOP’s impact on Cash Flow
Tax Deductible Contributions
Tax Deductible Dividends when used to repay debt
Tax-Free S corporation Income
Government reimbursable
Lender repayment
Repurchase obligation
Implementation and ongoing costs

20. Advantages Disadvantages
Company
Substantial tax savings
Increased cash flow
Pre-tax dollars repay debt
Tax-free income, S Corp ESOP stockholder not subject to federal and most state income tax
Stockholders
Liquidity in part or whole
IRC 1042 “tax-free” rollover
Selling shareholders can remain involved (if desired)
Leadership
Minimal disruption
Flexible alternatives to motivate key performance typical
Employees
Share in equity growth
Research shows ESOP companies more likely to have other retirement-oriented benefit plans
Proven motivator
Retains key employees
Requires debt to purchase larger blocks of stock
Seller can finance with larger block of stock
Repurchase obligation
Planning for funding options important
Complexity
Experienced advisors essential

21. How does an ESOP impact ...
Corporate governance
Current owners who aren’t selling
Leadership going forward?

22. Corporate Governance ESOP Company Nomination Committee ESOP
Nomination Committee Nominates Board of Directors for Trustee to Vote
ESOP
Committee (Optional)
Board appoints
Board appoints
Board of Directors
Audit Committee
Board appoints/removes Trustee
Trustee(s)
Manages Day to Day Operations of the ESOP
Compensation
Committee
Company
Other
Committees
ESOP
Sponsor
* Trustee elects Directors from nominating committee’s slate

23. Current Owners (Who are not Selling)
The opportunity to have each employee focused on the same goal, growing shareholder value
The ESOP is one shareholder

24. Leadership and Management
Can be structured with minimal or no impact on current incentive and benefit plans
Participate in the ESOP
Shares typically awarded based on individual payroll as a percent of the total
Trustees normally approve equity based incentives for key management, over and above your participation in the ESOP

25. Synthetic equity
Generates value in relation to value of stock for key employees
Units issued by board of directors
Can be performance based
Typically vesting applies
Other Incentives
Existing plan(s)
Cash bonus, based on exceeding projections
Stock options
Deferred comp

26. Is an ESOP right for your Company?
The answer: it depends…
On shareholder goals and objectives
Estate planning, personal financial needs, time table, control
Company’s strategic plan
Projected growth, successor management, cash flow, employee benefits levels, ownership culture
Current economic considerations
Valuation, transaction financing, tax implications, current legislative environment
Paige

27. The process Phase I Decision Package Phase II Implementation Phase III
No fee
Confidential
Preliminary Analysis
Preliminary range of valuation
Financial Analysis
Feasibility study, creating a “decision package”
Phase I Decision Package
Independent transaction valuation
Plan and trust, and transaction documents
Financing, Bank and / or Seller
Employee Communications
Phase II Implementation
Employee education
Repurchase Obligation Planning
Annual administration and valuation
Phase III
Ongoing
Paige 27

28. Phase I: Feasibility Study
Solidify and modify goals and objectives
Advisors confirm tax implications
Preliminary value range provided by appraiser
Funding discussions
Transaction design(s) – viability confirmed by tax, legal and accounting teams
Review of all related documents, plans, buy-sell
In-depth financial analysis and modeling

29. Financial Analysis & Modeling
Based on projections
Relying on preliminary value range
Assesses cash flow, include repurchase obligation
Assesses compliance limitations
Payroll size and growth projection
IRC § 415 limitation, 409(p), etc.
Models shareholder positioning over lifecycle of ESOP
Estimates tax savings
changed asses to assesses

30. Financial Analysis & Modeling (continued)
Coordinating ESOP with existing plans, benefit levels, and executive compensation programs
Identifies show stoppers
“C” or “S” corporation? IRC 1042
Models funding sources
Illustrates impact of plan design
This is an iterative process!

31. ESOP Team Corporate advisory team:
CPA, corporate counsel, financial advisor(s), etc. Supporting and advising as needed
ESOP consultant
Prepares feasibility study, a decision package to ascertain viability, and “quarterbacks” implementation
Independent appraiser
Determines fair-market value
Trustee(s)
Acts on behalf of the ESOP and purchases stock
ESOP counsel / Corporate Counsel
Drafts plan, trust and transaction documents
Advises trustee(s) and other fiduciaries
Banks
Providing funds to facilitate transaction
Third party plan administrator
Provides annual record keeping and compliance testing

32. Next Steps Learn more www.esopservices.com References
Selected upon request
Partial list at
Call or with questions!
ESOP Videos (esopinfo.org)
Feasibility Study

33. ESOP Services, Inc. www.esopservices.com Paige Ryan
Founded in 1984, ESOP Services, Inc. responds to the needs of business owners to understand and analyze the ESOP’s impact on the company, shareholders, and employees, focusing on the financial aspects of cash flow, tax savings, shareholder liquidity, and employee benefits.
We specialize in all aspects of Employee Stock Ownership Plans for both private and public companies throughout the United States and internationally. Our unique approach emphasizes the financial aspects of ESOPs, while coordinating the many diverse elements necessary to successfully establish an ESOP.
Paige Ryan
San Diego, CA 92142
Ron Gilbert
Scottsville, VA 24590 33