Commentary on Employee Stock Ownership Plans

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In response to recent news articles concerning Employee Stock Ownership Plans (ESOPs), Evan L. Rhodes, president of American Business Resource Corporation, and a nationally recognized ESOP expert, comments on ESOPs in general and S-Corporation ESOPs in particular.

Employee Stock Ownership Plans (ESOPs) have been in the news lately as a financial strategy to take a company from public to private. An ESOP is a type of employee retirement benefit plan designed to invest primarily in employer stock. To establish an ESOP, a firm sets up a trust and makes tax-deductible contributions to it. Employee Stock Ownership Plans have been around since the 70's and have been well-regarded as a solution for large, public companies. Many small business owners are unaware that Congress reformed ESOPs in 1998 to enable small, privately owned companies to qualify for it.

Evan Rhodes, president of American Business Resource Corporation, and a nationally recognized ESOP expert, points out some of the things that S-Corporation ESOPs can do:

  • Increase cash flow. In 1998, Congress took steps to radically reform ESOPs: they decided to include S-Corporations as a type of company that could be sold to an ESOP. Additionally, they provided that if the business was sold to an ESOP, the company would be exempt from all income tax on its profits. The money the owner used to pay in taxes may now be used to partially or fully fund the sale of the business to the ESOP. Not only does this create a market for smaller companies, it also funds the transaction through tax savings and provides retirement benefits to employees.
  • Attract and retain employees. Generation-X'ers don't work for just a paycheck; they want an equity stake in something they are helping to build. With an ESOP, all employees and especially key employees, have adequate incentive to growthe business. Their beneficial interest in the ESOP is calculated based on their salaries as a percentage of overall payroll. The higher their salary the more beneficial interest they get in the ESOP. The better the business does, the higher the ESOP value becomes. These employees can potentially make more off the ESOP than their 401(k). In fact, many employees have been known to retire as millionaires simply by having an ESOP in place.
  • Transfer a business. The S-ESOP is an excep¬tional way to transfer business interests to future gener¬ations, especially in situations in which the business interest has cash flow and is expected to appreciate substantially in value. The transaction is structured as a sale. Since an ESOP is a retirement plan, the company no longer pays most state or federal income taxes, greatly increasing cash flow for the company while offering an excellent exit strategy for the owner and an excellent reason for family members and employees to remain with the company.

Mr. Rhodes cautions that ESOPs are not for everyone:

  • The ESOP program is not currently available to professional associations or professional corporations.
  • The S-ESOP should only be considered by business owners who have a profitable business, have more than ten employees, want to keep the business going, and keenly understand the difference between ownership and control.
  • In the last several years, there has been a steady increase of businesses forming as, or converting to, an L.L.C. structure. While this structure is called a corporation, its legal structure is closer to that of a partnership. Since there is no issuance of stock in an L.L.C., you cannot directly install an ESOP in an L.L.C. For those with a 'C' Corporation and other entity structure such as an L.L.C., the business can be converted to an 'S,' but only after proper tax and legal planning.

Mr. Rhodes concludes, "When properly designed, the S-Corp ESOP can help lower taxes, increase cash flow, motivate employees and best of all, fund the owner's exit while creating a competitive advantage using monies previously used to pay taxes."

To interview Evan Rhodes about Employee Stock Ownership Plans, call (480) 556-9928 ext. 111.

Evan L. Rhodes is owner and president of American Business Resource Corporation (http://www.abrc-esop.com), a company based in Scottsdale, Ariz. that focuses 100% on helping private companies design and implement Employee Stock Ownership Plans.

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MARCIA RHODES
ABRC
602-793-1561
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