Good Morning Truckee! Business Succession 2017 Opportunities-Options-Impact

Transcription

1 Good Morning Truckee! Business Succession 2017 Opportunities-Options-Impact

2 Agenda Setting the Stage - The Closely-Held Wealth Dilemma Business Succession Alternatives Employee Ownership Succession for Generations of Business Success Managing Valuation in Business Succession Personal and Community Impacts 2

3 Business Ownership Today: Risk and Opportunity 3

4 The Closely Held Wealth Dilemma 4

5 5

6 The Life Stages of a Business Entrepreneurial businesses have a life-cycle: Getting started Moving beyond critical mass Making the right growth decisions Dealing with adversity Reviving a static business and then comes Business succession planning 6

7 The Currency of Equity Tactical: Tax and Cash Benefits Strategic: Engaged Employees Statement of Values: Ownership Culture Compensation Substitute Key Executive Compensation Broad Based Equity Incentives Profit Sharing Stock Bonus Plans Gain Sharing Value Plans Employee Ownership 7

8 Overriding Business Succession Issues Public Markets represent a relatively small percentage of the wealth in the U. S. (or the World, for that matter). The vast majority of wealth is not in a liquid form. Illiquid assets are hard to value and even harder to access. Within the next 10 years, a large percentage of the corporate wealth in the U. S. will change hands as the Baby Boomers Retire. How Does that play out? 8

9 Closely Held Company Owner s Issues Self and Spouse How to Create an Income Stream for Life After Retirement? And How to Retire Early Enough to Enjoy It? Children and Other Heirs How Best to Provide for Heirs both In the Business and Outside of it? Business Continuation How to Provide for Business Succession without Risking The Stability of the Company? Employees How to Protect Employees and the Community from the Negative Result of Unplanned Transition? Tax and Finance How to Make the Best Use of Assets and Minimize Estate and Gift Taxes at the Same Time? Pride and Philanthropic Intentions How Best to Leave a Legacy that Lets a Life s Work Continue to Serve the Owner s Objectives? 9

10 Owners Expectations Minimum acceptable PRICE TIME Horizon for completing the sale of the business CONTINUITY of the business (e.g., management team, employees, and vendors) Continued INVOLVEMENT (Or Not) Characteristics of an ACCEPTABLE BUYER Other RELATED OUTCOMES (Effect on Family, Charitable Intentions, Etc.) 10

11 Closely Held Business Alternatives Some may be handed down to future generations, Some may be large enough to go public, Some may be attractive to synergistic buyers for high multiples, Some may be attractive to financial buyers, but Many may just wind up being liquidated!!! A Better Alternative for Many Companies! Partner with employees to sell the company for full fair market value using an ESOP! 11

12 Sharing the Future with Employees Stakeholders (including employees) can be put in a position to compete for the right to take this equity into the next generation of private ownership using an Employee Stock Ownership Plan (ESOP). ESOPs can provide a controlled, friendly buyer at Fair Market Value. Tax laws provide significant incentives for sales to employees through ESOPs ESOP is the most tax and cost effective way to finance a purchase of shares of a closely-held business. ESOPs can create liquidity in an illiquid estate to better coordinate with estate plans. Management/Employee buy-out is a way to preserve an entrepreneur s legacy and gain access to all or part of their equity at the same time. Employees are often the most appropriate partner in sustaining a business into the next generation! 12

13 The Option that Addresses the Most Issues Employee Stock Ownership Plan (ESOP) Your Partner in Business Succession 13

14 What Is an ESOP? Defined contribution retirement plan like Profit-Sharing or 401(k) with two significant differences: Required to invest primarily in the stock of the sponsoring company May borrow money backed by the credit of the Company in order to do so (leveraged ESOP) Can be used for stock transfers from existing shareholders or as a capital raising vehicle acquiring newly issued shares from the Company A versatile tool used to accomplish a wide range of financial and employee relations objectives 14

15 ESOP s Role in Succession Planning ESOPs provide a controlled, friendly buyer at fair market value. Tax laws provide significant incentives for sales to employees through ESOPs ESOP is the most tax and cost effective way to finance a purchase of shares of a closely-held business. ESOPs can create liquidity in an illiquid estate to better coordinate with estate plans. Employee buy-out is a way to preserve a legacy and get all or part of an entrepreneur s equity out of the business at the same time. 15

16 Basic ESOP Structure Basic ESOP Funding Structure 1. Company Contributes Cash (Or New Issue Shares) to ESOP Company 2. ESOP Trustee Applies Cash to Purchase Shares At Current FMV 3. Employees Build Equity Over Time Through Allocations ESOP Trust Sharehold ers 16

17 Leveraged ESOP Leveraged ESOP Transaction Structure Company 1. Bank or Other Lender Makes Term Loan to Company 2. Company Loans Proceeds to ESOP. (1) Lender ESOP Trust Shares (3b) 3. ESOP Trustee Purchases Shares from Shareholders Shareholders 17

18 Amortization is 100% Pre-Tax Repaying the Loan Company 1. Bank Loan is Repaid Over Negotiated Period (3) 3. ESOP Repays Debt to Company Lender 2. Company Makes Contribution or Dividend Payment to ESOP Suspense Account 4. Participant Accounts Accrue Stock As the ESOP Loan is Repaid Participant Accounts (2b) 18

19 Special Incentive for Sellers Deferral of Tax on Sale To ESOP 19

20 Sellers Incentive: 1042 Tax Deferred Rollover Seller can elect to defer gain on privately held C corporation shares sold to ESOP by reinvesting all or any portion of the sales proceeds in qualified replacement securities Replacement securities are stock or debt instruments of a domestic operating corporation Replacement securities must be acquired within 12 months following transaction After the sale, ESOP must own at least 30% of company Seller must have owned stock for at least three years prior to sale Seller cannot have acquired the stock in a compensatory stock option plan, nor from a qualified retirement plan Seller, certain related individuals, and greater-than-25% owners generally cannot participate in allocations of shares that have been subject to this treatment. 20

21 ESOP Tax Deferred Rollover Company (C corporation) Loan Sale of Appreciated Securities Without Capital Gains Taxes Lender Loan IRC SEC ESOP Trust Shareholders Replacement Securities 21

22 Special Benefits for S-Corporations Fully Tax Free Earnings 22

23 ESOP S-Corporation Effective in 1998, ESOPs were authorized to become shareholders in Sub-chapter S corporations In an S-corporation Taxes are paid ratably based on relative shareholdings Shareholdings are attributed ratably throughout each year Earnings are typically distributed to the shareholders sufficient to cover their tax liability Undistributed earnings are applied to an accumulated adjustments account and either withdrawn tax free at a later date or applied to increase the shareholder s basis in shares ESOP, as a Shareholder, is attributed a ratable portion of the corporations earnings each year. Since the ESOP is tax exempt, its share of S-Corporation earnings are tax free! There is no flow-through of tax to participants, except with reference to the value of their shares on distribution. 23

24 ESOP S-Corporation The Ultimate Tax Shelter Taxable Shareholders Pay Tax on 1040 S-Corporation (3) Shareholders IRS (1) (2a) Earnings Are Attributed To Shareholders Based on Their Relative Stock Ownership ESOP is Tax Exempt So Earnings Are Tax Free 24

25 ESOP Benefits In Summary Tax-Free Sale of Stock at Independently Determined Fair Market Value (Section 1042) Seller may elect to reinvest proceeds and defer (or eliminate) capital gains tax on the transaction Fully Tax-Deductible Financing Significant Improvement in: Employee Morale and Productivity Retirement Benefits Company Cash Flow Tax-Free Corporate Income 25

26 Significant ESOP Considerations 2017

27 Who Controls an ESOP Company? Corporate Responsibilities and Positions do Not Automatically Change as a Result of the ESOP The ESOP Trustee Represents the Interests of the ESOP and its Participants If there is a Major Corporate Decision that Requires the Shareholders to vote, the Trustee will discuss it with Participants and ask for Advice. In the end, the Trustee will decide what is in the best interest of the ESOP. ESOP is a stake in the future value of the Company Employees share in the value that is being created, but the governance of the Company is not changed. 27

28 How is Stock Value Determined? Must be valued by independent third-party appraiser ESOP can pay up to fair market value Must be valued annually and as of the date of any purchase/sale Valuation is generally based on: Value of assets Capitalized earnings history Discounted future cash flow Comparison with publicly-traded comparable companies Premiums and discounts Marketability lack of marketability Control lack of control 28

29 29 Track Record?

30 Some Highlights of Research ESOP companies are 8 10% more productive after becoming employee owned than before. ESOP company retirees can be expected to retire with 2.5 to 4 times the retirement income they could expect otherwise. ESOP companies are less likely to lay people off in downturns, hire back faster and are only 1/5 as likely to go out of business. 30

31 What s the Score? (NCEO Research 2016) Type of Plan: Number of Plans: Total Participants: Employer Stock Held: Total Assets: Standalone ESOPs: million $102.9 billion $115 billion KSOPs: million $159.4 billion $1.12 trillion Total Literal ESOPs: million $262 billion $1.23 trillion Other ESOPlike Plans: million $22.2 billion $64 billion 31 Total: million $284 billion $1.3 trillion

32 Employee Ownership and Community Health General Social Survey: Post- Recession 12.1% of respondents lost jobs but only 2.6% of employeeowners 32 Translated into community impact without employee ownership, 1.8 million more jobs would have been lost a benefit in federal tax revenues of $14 to $23 billion per year

33 More Recent Research Message is the Same! Sampling Recent Research from NCEO (Kellogg Foundation Grant) ESOP creates median net worth 96% higher than non-esop employees ESOP Companies Pay 33% better median salary Employee Owners have median tenure 53% longer than others NBER Data Show: 33 The Extent of employee ownership is persistently linked to healthier county economies along lines of employment and income stability.

34 34 Questions?

35 Contact Information: Anthony Mathews, Beyster Institute California Center for Employee Ownership Rady School of Management University of California, San Diego 9500 Gilman Drive #0553 La Jolla, CA (858)