1. The ESOP Concept: Is Your Trucking Company a Good Candidate?
April 24, 2017
Mark A. Flinchum, CPA

2. Agenda The ESOP Opportunity The ESOP Structure and Operation
ESOP Advantages and Disadvantages
ESOP Profile and Third Party Buyout Comparisons
Next Steps for Interested Companies
Questions

3. The ESOP Opportunity

4. What is an ESOP? Tax-qualified retirement plan
Operates similar to a profit sharing or 401(k) plan
Investment primarily in employer stock
Used as a corporate finance and business succession tool

5. Why an ESOP? ESOP purchases the business with tax deductible dollars
In properly structured sale, the seller of C corporation shares pays no capital gain on the sale
Employees are incentivized to grow the company
100% ESOP-owned company can operate generally tax-free

6. Alternative to Sale to Strategic Buyer
Control over timing of sale
Greater job security for current employees
Maintain independence of company
Flexibility to quickly react to opportunities and challenges in the marketplace

7. The ESOP Structure and Operation

8. Typical Leveraged ESOP Structure1
cash
outside loan 6 2
inside loan
cash 5 4
stock
cash 3

9. Post-Transaction Cash Flows1
retirement contribution
loan re-payment 2 3 4
loan re-payment
shares released

10. Ownership ESOP Trust is stockholder of record
Beneficial ownership on behalf of plan beneficiaries (the employees)
Trustee of the ESOP must be named
External Trustee (bank) or Internal Trustee
Takes on fiduciary responsibility
ESOP does not have to own 100% of Company’s stock

11. Plan
Complexity of drafting ESOP plan requires experienced ERISA legal counsel
Terms that most impact ESOP participants:
Plan eligibility (ex. one year from start of employment)
Vesting of contributions (three yr. Cliff / five yr. Step)
Payment of balance upon retirement (ex. within first year, except in cases of large balances)

12. ESOP Advantages and Disadvantages

13. ESOP Advantages - Seller
To the Seller
Seller may retain a portion of equity
Known Buyer/Exit Strategy
Diversify Seller’s Net Worth
Section 1042 Rollover
Benefit available to seller of C-Corporation stock
Defer Capital Gains on Stock Sale
Eliminate Capital Gains (step-up basis, if assets held at death)

14. ESOP Advantages - Company
To the ESOP Company
Use pre-tax cash flow to repay indebtedness (ESOP contribution is tax deductible, use contribution to repay loan)
Enables faster repayment of debt with improved cash flow
Can be used as a financing device
Avoid using after-tax dollars to redeem owner’s shares
Retention of motivated employees
Continuity of management
Higher Sales, Job Retention - ESOPs increase sales, employment, and sales/employee by about 2.3% to 2.4% per year over what would have been expected absent an ESOP (Rutgers/2000)
NCEO Website: Summary of Employee Ownership Research on their site
When ownership and employee workplace participation programs are combined, substantial gains result 8%-11%. Participation plans alone, however, have, at best, spotty or short-lived results.

15. S-Corporation ESOP Tax Advantage
Compelling S-Corp ESOP Advantage
Earnings inside your 401(k)/retirement plans are not taxed until you take distribution
ESOP is an ERISA plan just like 401(k)
Therefore, S-Corp ESOP’s earnings are not taxable in the current period. They are only taxed when participants take distribution upon death, disability, retirement, etc.

16. ESOP Advantages - Employees
To Employees
Employees participate in the appreciation of the company’s value
Avoid sale to a third party which could affect jobs
Avoid potential loss of jobs during economic downturns - 3% of employees with employee stock ownership were laid off during Great Recession compared to a 12% rate for employees without employee stock ownership (National Science Foundation & GSS/2012)
Increased job satisfaction
Exit strategy (put right)
More Retirement Assets - ESOP participants have approximately 2.2 times as much in their accounts as participants in comparable non-ESOP companies with Defined Contribution plans (EOF/2010)

17. ESOP Disadvantages ESOP can only pay Fair Market Value
Strategic premium might be gained by sale to industry participant or ‘roll-up’ buyer
Owners may not get 100% ‘cash out’
Even with high leverage, a 100% sale will require taking back a “seller note” for a portion of the sale price
Complexity of ESOP and regulation

18. C-Corporation Planning
C-Corporations selling stock to ESOP are eligible for Section 1042 capital gain deferral
To qualify for Section 1042, ESOP must:
Own at least 30% of company after the sale
Seller must have held the stock for at least three years
Seller must purchase securities defined as “Qualified Replacement Property” (QRP)

19. C-Corporation Planning (continued)
If a selling shareholder elects Section 1042 treatment, the shareholder (and family members) may not participate in the ESOP Plan for the latter of 10 years, or the payoff of the acquisition debt (“Inside Loan”)
Capital gains tax of 20% still historically low. Consider evaluate paying tax and not deferring under Section 1042 depending on facts and plans
If forming or increasing ESOP ownership to 100% may want to consider accelerated plan funding to create tax NOLs tax deductions

20. ESOP Profile and Third Party Buyout Comparisons

21. ESOP Candidate Profile
Owner approaching retirement
Capable management team to succeed owner
Unused debt capacity
Profits to support ESOP debt service
Company size (more cost effective benefit)
Motivated by tax advantages
Motivated by “ownership culture” advantages
Desire to buy-out a minority shareholder
Limited third party / strategic buyers in market

22. ESOP vs. Third Party Buyout
Company controls timing
Buyer controls timing
Price base upon independent valuation
Strategic buyers may pay “synergistic” premium
Payment depends upon company’s borrowing capacity
Buyer’s more likely to arrange own financing
Seller financing can be used to improve purchase price
Purchase price more likely to consist of stock, or include earn out features
ESOP structure more likely to preserve jobs
More likely to result in layoffs and downsizing
ESOP structure is an incentive to all employees to increase profitability
Generally fewer incentives to rank and file employees

23. ESOP vs. Third Party Buyout
Smaller companies tend to be more nimble in a highly competitive environment
As part of a larger organization, there is less flexibility to quickly react to changing conditions
Depends upon company’s borrowing capacity
Greater ability to infuse capital for expansion and acquisitions
More flexibility to sell part of the company and for sellers to retain growth potential
Aside from earn out provisions, buyers tend to purchase substantially all of the company
Executive potential for participation is restricted only by their ability to grow the company
Executives tend to be restricted by company policies and practices regarding incentives
ESOP purchases company stock including existing liabilities
Generally purchase assets leaving shareholders with existing liabilities

24. Next Steps for Interested Companies

25. From Ideas to Actions
Will an ESOP help us achieve the varying objectives?
Board
Shareholders
Management
Employees
Stakeholders – how will it effect each????

26. ESOP Feasibility Analysis
A Feasibility Study will allow corporate decision makers to determine if, and to what extent, an ESOP can assist the board, management and shareholders in achieving desired objectives
- Smiley, et. al., “Employee Stock Ownership Plans”

27. ESOP Feasibility Analysis
What is included:
Valuation Analysis
Deal Structure discussion & analysis
Financing options & alternatives
Potential for §1042 Rollover
Circumstances may lead to creating two or more Scenarios
* 30% Transaction vs. 100% Transaction
* Bank Financing vs. Seller Financing

28. Stage 1: Planning & Analysis
Information Gathering
Establish Objectives
Feasibility Analysis on alternatives that might meet established objectives
ESOP
Third Party Sale
Family
Succession
Review Findings and Conclusions
Decision

29. Sell Side (Shareholder(s))
ESOP Deal Team
Valuation Advisor
Shareholder Counsel
Same as Company Counsel?
CPA/Tax Advisor
Sell Side (Shareholder(s))
Trustee Counsel
Plan Administration (TPA)
Buy Side
(Trustee)
Management
Company Counsel
Bank
Company

30. Stage 2: ESOP Formation Build ESOP Deal Team
Complete Corporate Restructuring
(if needed)
Raise Capital for Transaction
(Bank / Private Equity / Employees)
Draft
ESOP
Plan
Valuation
Opinion
Transaction
Doc’s
Financing
Trustee Deal Review, Approval
Close Transaction

31. Questions?
Mark Flinchum P E