Why An Employee Stock Ownership Plan?

Some business owners plan to sell their business to enable their retirement. Even owners who intend to remain active in their business may want to diversify their holdings simply for the safety it could provide. Of course, choosing a business partner, while allowing you to diversify your investments, can be risky, especially if it involves giving up some level of management control.

Succession planning and estate valuation tends to be made easier where a potential purchaser has already been identified. An ideal situation for some business owners is to create some liquidity from the value of their business without incurring capital gains, and having the business ownership interests stay in friendly hands.

Explore an Employee Stock Ownership Plan (ESOP)

A strategy that can be worth exploring involves selling all or part of your business to an Employee Stock Ownership Plan (ESOP). When establishing an ESOP, you must comply with a number of technical requirements and may incur significant transaction costs due to expenses such as an appraisal and potentially an audit. The stock sold to an ESOP has to have been owned for at least three years¹. The ESOP has to own at least 30% of the company after the deal².

Potential Tax Benefits of an ESOP

Some very attractive tax benefits which can justify the ESOP are available to sellers. For instance, tax rules allow a business to be sold to an ESOP by a seller who could avoid capital gains tax by investing the proceeds in Qualified Replacement Property (QRP) ³.

As long as the seller holds onto the QRP, the taxable gain on the sale of business will be deferred. The seller will have a lower basis in the QRP⁴. And, if the QRP is sold or otherwise disposed of during the seller’s lifetime, the deferred gain will be recaptured⁵. Special financial products have been developed which make a QRP attractive, offering business sellers a balance of investment participation and security.

When a sale to an ESOP involves leveraging, both the interest paid on the loan and the principal repayments can be deductible by the business.

Consult with Your Attorney and Accountant When Considering an ESOP
Selling to an ESOP should be carefully planned, with advice from the appropriate legal and tax professionals. Ideally, exploring and evaluating different alternatives in selling a business might take several years.