ABRC-ESOP

Evan L. Rhodes: ESOPs are an effective motivational tool. With an ESOP, all employees, especially key employees, have adequate incentive to grow the business. Their beneficial interest in the ESOP is calculated based on their salaries as a percentage of overall payroll. The higher their salary the more beneficial interest they get in the ESOP. The better the business does, the higher the ESOP value becomes. These employees can potentially make more – as much as two to five times more – in the ESOP than their 401(k), without affecting take home pay.

Evan L. Rhodes: The basic structure of the S-Corp ESOP consists of a trust wherein the single shareholder of that trust is the ESOP. The S-ESOP, by law, is a tax-free entity. This means that the S-Corporation, which is a pass through entity, is taxed at the shareholder level, so the business becomes free of federal taxes. For those with a ‘C’ Corporation and other entity structure, the business can be converted to an ‘S,’ but only after proper tax and legal planning.

Congress encourages ESOPs as a method of strengthening the free private enterprise system and small business growth while simultaneously providing retirement programs for the baby boomers and future generations. Simply put, the more businesses stay open, the more jobs there are resulting in more revenue for the government.

Evan L. Rhodes:: Employee Stock Ownership Plans have been around since the 70’s. However, the Employee Stock Ownership Plan for S-Corporations – what I call S-ESOP – has only been in place for the last nine years. In 1998, Congress took steps to radically reform ESOPs: they decided to include S-Corporations as a type of company that could be sold to an ESOP. Additionally, they provided that if the business was sold to an S-ESOP, the company would be exempt from all income tax on its profits. The money the owner used to pay in taxes could now be used to partially or fully fund the sale of the business to the S-ESOP. Not only does this create a market for smaller companies, it also funds the transaction through tax savings and provides retirement benefits to employees.

Evan L. Rhodes: Many small to mid-size businesses face a transition dilemma: they are either too small to be bought by a public or private equity company, too expensive for a third party buyer, or too valuable to close down. Several dream about an IPO but are fazed by financial markets now demanding that companies show a large and growing market opportunity, sustainable business model, meaningful revenues with significant international exposure, just to name a few IPO criteria. One option that is proving viable for closely-held businesses is the ESOP, which stands for Employee Stock Ownership Plan.

Question: What should business owners be doing to prepare for retirement?

Evan L. Rhodes: Business owners in the 50+ age bracket face a rude awakening. These baby boomers will want to exit and retire at a time when it is increasingly more difficult to find buyers for their business. For the last six years, the average number of businesses offered for sale and the number actually sold has been fairly lopsided. In 2001, over 1.5 million businesses were offered for sale yet only 250,000 were successfully sold (1 out of every 6). If this trend continues, five businesses out of every six will have to fold. Business owners should start planning seriously. They might consider implementing an Employee Stock Ownership Plan or ESOP.