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Kelly O. Finnell, J.D., CLU, AIF® President, Executive Financial Services, Inc.
ESOPs and Estate Planning
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Next Big Estate Planning Opportunity
2
Baby Boomer Business Owners
72% Planning for Monetization Event
62% Planning in the next 5-6 Years
Source: PricewaterhouseCoopers, Trendsetter Barometer™
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Next Big Estate Planning Opportunity
3
Baby Boomer Business Owners
Source: White Horse Advisors, Survey of Closely-Held Business Owners
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Monetization Planning Strategies
4
Lifetime Gift to Family Member
Sale to Third Party
Private Equity Group
Strategic Buyer
Management Buy-Out
Traditional Exit
Paths
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Monetization Planning Strategies
5
Lifetime Gift to Family Member
Sale to Third Party
Private Equity Group
Strategic Buyer
Management Buy-Out
Traditional Exit
Paths
Employee Stock Ownership Plan (ESOP)
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Did You Know . . .
Companies Can
Owners Can
6
Deduct Loan Principal
Deduct Dividends Paid
Operate as Tax-Exempt Entity
Control Company After Sale
Sell Company Tax-Free
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Did You Know . . .
7
ESOPs Create Estate Planning Opportunities
Post-Transaction Drop-In-Value
Minority Interest Discount
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Agenda
Overview
Tax Advantages
Key Issues
Estate Planning
8
ESOP Candidates
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ESOP Overview
What is an ESOP?
How Does an ESOP Work?
9
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What is an ESOP?
10
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What is an ESOP?
11
Qualified Retirement Plan
2½ times Greater Contribution
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What is an ESOP?
12
Tax Efficient Liquidity
Keep Control
Ensure Legacy
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What is an ESOP?
13
Pre-Tax LBO
Tax-Exempt Corporation
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14
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How Does an ESOP Work?
15
Stock
Cash & Seller Note(s)
Selling Shareholder(s)
Outside Loan Company
ESOP & ESOP Trust
Inside Loan
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Tax Advantages
Corporate Pre-Tax Debt Payment
16
Tax-Free Stock Sale
Tax-Exempt Corporation
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ESOP Tax Benefits
17
$10M Sale of Stock
MBO Or
Redemption ESOP
ESOP Tax Savings
Proceeds to
Shareholders $7.62M(1) $10.0M $2.38M
Cost to Company $10.0M $6.6M(2) $3.4M
$5.78M
(57.8%)
(1)Assumes 23.8% federal tax on sales proceeds
(2)Assumes 34% federal corporate tax rate
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ESOP Tax Benefits
18
Assuming C-Corp Asset Sale Taxed at 35%
ESOP Sale $10,000,000
Taxable Sale $15,384,615
Net to Seller $10,000,000
Capital Gains Taxed at 23.8%
ESOP Sale $10,000,000
Taxable Sale $13,123,359
Net to Seller $10,000,000
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ESOP Tax Benefits
19
Tax-Affected AEBITDA Multiples
Tax Rate
0.0% 23.8% 35.0%
Mu
ltip
le
4.0 4.0 5.25 6.15
4.5 4.5 5.91 6.92
5.0 5.0 6.56 7.69
5.5 5.5 7.22 8.46
6.0 6.0 7.87 9.23
6.5 6.5 8.53 10.00
7.0 7.0 9.19 10.77
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ESOP Tax Benefits
20
NO TAX ON
CORPORATE
INCOME!
100% ESOP Owned S-Corporation
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ESOP Tax Benefits
21
$10M Sale of Stock
MBO Or
Redemption ESOP
ESOP Tax Savings
Tax on
Company’s
Income $792,000(1) $0M(2) $7.92M(3)
(1) Assumes corporate earnings of $2M per year and 39.6% tax rate
(2) Assumes 100% ESOP-owned S Corporation
(3) Assumes $792,000 per year for 10 years
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22
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23
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Key Issues in ESOP Planning
24
Valuation
Financing
Control
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25
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Valuation
26
Industry
Revenue
AEBITDA
100% Valuation
Multiple
Tax Status
Defense Contractor
$266M
$25.18M
$180M
7.15x
C-Corp
Manufacturing
$10M
$.923M
$6M
6.5x
C-Corp
3rd Party Logistics
$213M
$5.00M
$45.34M
9.61x – $4M debt
C-Corp
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Financing
27
Excess Company
Cash
Seller Notes
Bank Loan
+ + Total
Transaction =
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Financing
28
$2M $4M $4M $10M + + =
$6M Cash at Closing
$320,000/year (8% Interest + Warrants)
Excess Company
Cash
Seller Notes
Bank Loan
+ + Total
Transaction =
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Financing
29
Sources of Cash for Repayment
Tax Savings
401(k) Match
Owner’s Adjusted Salary/Bonuses/Perqs
Corporate Earnings
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30
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31
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Control
32
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33
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ESOP Estate Planning Opportunities
34
Estate, Gift, and Charitable Planning
with ESOPs
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Estate and Gift Planning
35
Key Concepts
Post-Transaction Drop-in-Value
Minority Interest Discount
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Post-Transaction Drop-In-Value
36
Pre-ESOP Post-ESOP
$10,000,000 Enterprise Value
$1,000,000 Excess Cash
($1,000,000) Debt
$10,000,000 Equity Value
$10.00 Price Per Share
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Post-Transaction Drop-In-Value
37
Pre-ESOP Post-ESOP
$10,000,000 Enterprise Value $10,000,000
$1,000,000 Excess Cash $1,000,000
($1,000,000) Debt ($6,100,000)
$10,000,000 Equity Value $4,900,000
$10.00 Price Per Share --
Minority Interest Discount ($1,225,000)
NPV of ESOP Tax Benefits $1,354,000
Post-Transaction Price Per Share $5.03
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Estate and Gift Planning
38
100% ESOP Transaction
Lifetime Gift of Warrants
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Estate and Gift Planning
39
Gift of Remaining Shares
Post-Transaction Drop-in-Value
Minority Interest Discount
51% ESOP Transaction
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Estate and Gift Planning
40
Gift of Remaining Shares
Post-Transaction Drop-in-Value
Minority ESOP Transaction
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Charitable Planning
41
Gift of Company stock to Charity or CRT
Income Tax Deduction
Charity or CRT sells stock to ESOP
ESOP owns stock
No Recognition of Capital Gain
Owner has income stream from CRT
Use CRT as § 1042 alternative
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Charitable Planning
42
Owner sells C-Corp. stock to ESOP
Elects § 1042 deferral
Owner makes gift of QRP to CRUT
Income Tax Deduction
No MID
Owner receives income for life
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ESOP Candidates
43
Business Owner Characteristics
Tax Motivated
Legacy Motivated
Control Motivated
Employee Motivated
Tried Sale and . . .
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ESOP Candidates
44
Company Characteristics
Tax Motivated
Equity Incentives
Strong Successor Management
Cash Flow (EBOC or AEBITDA) ≤ $1MM
Payroll (excluding Owner) ≤ $1MM
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ESOP Estate Planning Opportunities
45
Questions?