Baby boomer business owners will be looking to retire in droves over the next decade and this could result in more businesses for sale than can meet the demand to buy. This will likely drive prices down and make business succession strategies more difficult to accomplish retirement goals.
To prevent this scenario, it may be advantageous for some business owners to consider incorporating Employee Stock Ownership Plans (ESOPS) into their business succession and overall estate plans. Let’s take a look at how an ESOP works:
- First the company sets up a trust owned and operated by the company (this trust is the ESOP).
- Then instead of selling the business to a third party, the business owner sells the company to this trust (ESOP).
- The trust borrows the money to buy the company and uses the shares from the company as collateral.
- The employees of the company participate in owning shares of the ESOP (but it can be structured where they do not directly own shares in the company).
- As the company continues to operate it makes contributions to the ESOP to repay the loan.
- The loan is repaid, the collateral is released, and the additional funds are allocated to the employee participants.
Some companies use this as a liquidity strategy, but there are also numerous tax advantages to consider. ESOPS are subject to a lot of regulatory requirements and are therefore extremely complex to implement. It is not the solution for every business owner, but a company of sufficient size that has a management team that can continue the operations and has a strong probability of maintaining profitability may want to consider this option. It also rewards employees for their loyalty and allows them to partake in a form of ownership.
There are several estate planning benefits to ESOPS outside of the business succession benefits. The shareholders of the ESOP may transfer their shares to qualified replacement property (U.S. stocks and bonds). If the replacement property passes through to their estate at death, their heirs receive the step up in basis and may avoid significant capital gains taxes.
If the shareholders retain the shares and pass away, the ESOP serves as a ready buyer for the shares. This prevents heirs of the business owners from being forced to sell a business in distress or from having the shares lose significant value because there is no one to buy them.
ESOPs can also be used in gifting strategies for business owners to transition ownership to family members. There are numerous estate planning opportunities available with the use of ESOPs. For more information on business succession strategies, specifically the creation of ESOPs, as a way to ensure a smooth transition of ownership for your business, contact the knowledgeable attorneys at Stouffer Legal in the Greater Baltimore area. You can schedule an appointment by calling us at (443) 470-3599 or emailing us at office@stoufferlegal.com.
