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Planning for Your Retirement & The Future of

Your Business—the ESOP Alternative

Presented on April 28, 2014 to

NSGA Management Conference

James SteikerChairman & CEO SES Advisors, Inc.Tel: (215) 508 – 5643 Email: jsteiker@sesadvisors.com

Randy RuchRetired FounderSchuylkill Valley Sports, Inc.Tel: (610) 587-8061Email: randyruch@aol.com

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The Schuylkill Valley Sports ESOP Story

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About Schuylkill Valley Sports

• Schuylkill Valley Sports was founded in 1971 in Audubon, PA (Suburban Philadelphia)

• First expansion was in 1979 in Quakertown, PA

• By 2005 we had eighteen stores throughout eastern PA

• Randy Ruch owned 70% of the stock of the company

The Liquidity Challenge

• How does one cash-out and retire from this situation?

• SVS was a hybrid – approximately 70% retail and 30% team business

• Other retailers – no interest in the team side

• Other team dealers – no interest in the retail side

• Could current employees afford to buy me out – no

• ESOP (Employee Stock Ownership Plan) became a good option

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Determining Value

• How to value the company???

• That would determine the value of my 70% of the stock

• Typical price/earnings ratio (P/E) for the S&P 500 stocks is approximately 16

• Typical private small company sale is a P/E of 5 to 6 times EBITDA (Earnings before Interest, Taxes and Depreciation)

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How We Started the ESOP

• We hired an attorney/advisor – an ESOP specialist

• We hired an accountant – an ESOP specialist

• We approached a bank – to fund the deal

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Basic Structure

• Bank loans SVS the money

• SVS loan money to the ESOP to buy my stock

• ESOP buys my stock

• I deposit my proceeds at the bank to guarantee the SVS loan

• I control investment of the proceeds

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• SVS/Bank had agreed to a ten year amortization with a five year balloon payment

• On the anniversary of the loan, SVS paid 1/10th of the loan balance plus interest

• After five years the employees who owned the other 30% of the stock, took over the loan guarantee

• I was off the guarantee and in June, 2009, I fully retired

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The Money Flow

The ESOP Advantage

• Tax advantages for me – deferred capital gains on the sale of my SVS stock (with certain qualifications)

• SVS discontinued its Profit Sharing Plan and instituted the ESOP--instead of an annual company contribution to a profit sharing plan, the employees receive stock according to their W-2 earnings

• Instead of an annual profit sharing contribution (expense) the company paid down the ESOP loan

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THE ESOP APPROACH

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Why Care About ESOPs?The Problem of Liquidity and

Succession

• All businesses must be sold or transferred– privately held companies have no ready market

• Alternatives include sale to financial or strategic buyer, gift or sale to family or management, or ESOP

• Approach should be based on shareholder goals in the context of achievable alternatives

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Good ESOP Candidates

• Non-cyclical slow to medium growth

• Stable cash flow

• Ownership group interested in remaining involved/participating in the business

• Patient long-time horizon—not seeking immediate cash payment in full

• Ownership group concerned about employees and/or long term future of company/motivated by "legacy" or mission goals in addition to cash

• Lack of cash strategic buyers willing to pay significant premium for the company

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Some Core ESOP Advantages and Disadvantages

Advantages

• Tax efficient

• Shareholder directed process

• Control over timing

• Legacy

Disadvantages

• Complex

• Regulated

• Often involve Seller notes or guarantees

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What is an ESOP?

• ESOP = “Employee Stock Ownership Plan”

• Qualified deferred compensation plan under ERISA and Internal Revenue Code

• Similar to Profit Sharing and 401(k) Plans

• Must invest primarily in company stock

• Can be leveraged

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Typical Goals of ESOP Transactions

• Shareholder Liquidity

• Long-term succession plan

• Corporate and personal tax planning

• Ownership/Partnership incentive for key employees

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Significant ESOP Tax Preferences

• Effective deduction of principal on ESOP loan repayment

• Section 1042 Capital Gains Deferral

• Deduction of dividends paid on ESOP shares

• S Corporation ESOP non-recognition of corporate income

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Section 1042 Capital Gains Deferral

• Permits shareholders selling to an ESOP to defer indefinitely capital gains tax on sale of shares

• ESOP must own 30% of value of all company stock after sale

• Selling shareholders must purchase qualified replacement property (“QRP”)—stocks or bonds of any domestic operating corporation

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“S” Corporation ESOPs

• “S” Corporation income attributed to shareholders

• ESOP as S Corp shareholder pays no taxes on its share of corporate income

• No section 1042 Capital Gains Deferral

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How Does an ESOP Work?

• Company establishes an ESOP Trust

• ESOP Trust purchases company stock from shareholders or company

• Bank or seller provides financing to Company

• Company pays contributions or dividends to ESOP that ESOP uses to repay debt

• Company or ESOP repurchases shares from employees after termination

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Company

ESOP

Note &

Pledge

of Stock

Cash

Company Stock

Cash

Bank

Shareholders

Pledge of

QRP??

Cash

Note & Collateral

Initial “C” CorporationESOP Transaction

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Company

Bank and/or

Shareholder

ESOP

Release of Shares Pledged as

Collateral and Share Allocations

to Individual ESOP Accounts

Contributions or

Dividends ($$$)

Loan Payments ($$$)

Loan

Payments

($$$)

ESOP Loan Repayment

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Company

ESOP

Note &

Pledge

of Stock

Company

StockCompany Stock

Cash &

Sub. Note

Bank

Shareholders

Cash

Note & Collateral

Initial “S” CorporationESOP Transaction

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A Typical ESOP Transaction “Vision”

• One or more Section 1042 ESOP transactions to transfer most or all stock ownership to ESOP

• Synthetic equity (usually stock appreciation rights or phantom stock) granted to key management to allow key executives to own eventually 15-30% of economic value of entity outside ESOP

• “S” Corporation ESOP election

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Another Typical ESOP Transaction “Vision”

• “S” Corporation redemption of all of the stock held by current shareholders for cash and subordinated notes

• Synthetic equity (usually stock appreciation rights or phantom stock) granted to key management to allow key executives to own eventually 15-30% of economic value of entity outside ESOP

• Company uses “S” corp. tax-free operation to accelerate debt reduction

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Typical Company Structure Pre-ESOP

Existing

Shareholders

Management Team

hires and oversees

elect

Board of Directors

appoints and oversees

President

hires and oversees

Employees

Shareholders

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Typical Company Structure After ESOP

ESOP

Participants

ESOP

eligibility

requirements

are met

Management Team

hires and oversees

elect

appoints and oversees

hires and oversees

Board of Directors

President

ESOP

Trustee

are

represented

by

appoints

Employees

Existing

Shareholders

Shareholders

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Steps in an ESOP Transaction

• Feasibility study

• Financing

• Appraisal

• Plan Design

• Legal Documents

• Closing

• IRS Determination Letter

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Ongoing ESOP Items

• Annual appraisal update

• Annual recordkeeping and administration

• Repurchase obligations

• Communications training and education

• Legal compliance

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Questions?