ESOPs and Estate Planning. Kelly O. Finnell, J.D., CLU, AIF President, Executive Financial Services, Inc.

Transcription

1 ESOPs and Estate Planning Kelly O. Finnell, J.D., CLU, AIF President, Executive Financial Services, Inc.

2 Next Big Estate Planning Opportunity Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning in the next 5-6 Years Source: PricewaterhouseCoopers, Trendsetter Barometer 2

3 Next Big Estate Planning Opportunity Baby Boomer Business Owners Source: White Horse Advisors, Survey of Closely-Held Business Owners 3

4 Monetization Planning Strategies Sale to Third Party Traditional Exit Paths Strategic Buyer Private Equity Group Lifetime Gift to Family Member Management Buy-Out 4

5 Monetization Planning Strategies Sale to Third Party Traditional Exit Paths Strategic Buyer Private Equity Group Lifetime Gift to Family Member Management Buy-Out Employee Stock Ownership Plan (ESOP) 5

6 Did You Know... Owners Can Sell Company Tax-Free Control Company After Sale Companies Can Deduct Loan Principal Deduct Dividends Paid Operate as Tax-Exempt Entity 6

7 Did You Know... ESOPs Create Estate Planning Opportunities Post-Transaction Drop-In-Value Minority Interest Discount 7

8 Agenda Overview Tax Advantages Key Issues Estate Planning ESOP Candidates 8

9 ESOP Overview What is an ESOP? How Does an ESOP Work? 9

10 What is an ESOP? 10

11 What is an ESOP? Qualified Retirement Plan 2½ times Greater Contribution 11

12 What is an ESOP? Tax Efficient Liquidity Keep Control Ensure Legacy 12

13 What is an ESOP? Pre-Tax LBO Tax-Exempt Corporation 13

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15 How Does an ESOP Work? Outside Loan Company Selling Shareholder(s) Stock Cash & Seller Note(s) Inside Loan ESOP & ESOP Trust 15

16 Tax Advantages Corporate Pre-Tax Debt Payment Tax-Free Stock Sale Tax-Exempt Corporation 16

17 ESOP Tax Benefits $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 17

18 ESOP Tax Benefits Capital Gains Taxed at 23.8% ESOP Sale $10,000,000 Taxable Sale $13,123,359 Assuming C-Corp Asset Sale Taxed at 35% ESOP Sale $10,000,000 Taxable Sale $15,384,615 Net to Seller $10,000,000 Net to Seller $10,000,000 18

19 Multiple ESOP Tax Benefits Tax-Affected AEBITDA Multiples Tax Rate 0.0% 23.8% 35.0%

20 ESOP Tax Benefits 100% ESOP Owned S-Corporation NO TAX ON CORPORATE INCOME! 20

21 ESOP Tax Benefits $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 21

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24 Key Issues in ESOP Planning Valuation Financing Control 24

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26 Valuation Industry Defense Contractor Manufacturing 3rd Party Logistics Revenue $266M $10M $213M AEBITDA $25.18M $.923M $5.00M 100% Valuation $180M $6M $45.34M Multiple 7.15x 6.5x 9.61x $4M debt Tax Status C-Corp C-Corp C-Corp 26

27 Financing Excess Company Cash Bank + + Loan Seller Notes = Total Transaction 27

28 Financing Excess Company Cash Bank + + Loan Seller Notes = Total Transaction $2M $4M $4M $10M + + = $6M Cash at Closing $320,000/year (8% Interest + Warrants) 28

29 Financing Sources of Cash for Repayment Tax Savings 401(k) Match Owner s Adjusted Salary/Bonuses/Perqs Corporate Earnings 29

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32 Control 32

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34 ESOP Estate Planning Opportunities Estate, Gift, and Charitable Planning with ESOPs 34

35 Estate and Gift Planning Key Concepts Post-Transaction Drop-in-Value Minority Interest Discount 35

36 Post-Transaction Drop-In-Value 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 36

37 Post-Transaction Drop-In-Value 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 $

38 Estate and Gift Planning 100% ESOP Transaction Lifetime Gift of Warrants 38

39 Estate and Gift Planning 51% ESOP Transaction Gift of Remaining Shares Post-Transaction Drop-in-Value Minority Interest Discount 39

40 Estate and Gift Planning Minority ESOP Transaction Gift of Remaining Shares Post-Transaction Drop-in-Value 40

41 Charitable Planning Gift of Company stock to Charity or CRT Income Tax Deduction Charity or CRT sells stock to ESOP No Recognition of Capital Gain ESOP owns stock Owner has income stream from CRT Use CRT as 1042 alternative 41

42 Charitable Planning Owner sells C-Corp. stock to ESOP Elects 1042 deferral Owner makes gift of QRP to CRUT Owner receives income for life Income Tax Deduction No MID 42

43 ESOP Candidates Business Owner Characteristics Tax Motivated Legacy Motivated Control Motivated Employee Motivated Tried Sale and... 43

44 ESOP Candidates Company Characteristics Tax Motivated Equity Incentives Strong Successor Management Cash Flow (EBOC or AEBITDA) $1MM Payroll (excluding Owner) $1MM 44

45 ESOP Estate Planning Opportunities Questions? 45