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W W W. M A I N E B I Z . B I Z 15 A P R I L 3 0 , 2 0 1 8 H OW TO B Y B I L L H A S K E L L A s business owners consider tran- sition and liquidity options, there are typically three choices: sell to a strategic buyer, a fi nancial buyer or an employee-management group. Selling to an outsider means change — the company's culture and vision are frequently altered and, due to acquisi- tion debt, there are virtually always cost- saving measures (downsizing, job losses, relocation, etc.). When employees buy, they already embrace the current culture and vision and have no desire to downsize. However, employees generally lack the resources to fi nance a purchase. While some advisors advocate periodic grants of stock to employees (or debt-fi nanced employee purchases), these alternatives cause signifi cant tax leakage and are not optimal. A way to facilitate a transfer to employee-managers is with an Employee Stock Ownership Plan. ESOPs are tax exempt, so a transfer can occur without tax implications. Also, employees don't have to contribute their money for their ESOP benefi ts. e key things to know: 1. In 1998, Congress enacted legislation to motivate owners of closely held businesses to let their employees share in the company's stock performance. 2. Congress used the tax code as the mechanism to create an incentive, providing that, if a sub S company redeems its shares from its owners (for cash and/or notes) and then transfers 100% of the shares to an ESOP, the company is no longer subject to federal or (in most cases) state income taxes in perpetuity. 3. e tax savings are used to pay off the owners' notes and to provide additional cash fl ow to the company. 4. An ESOP transaction can be struc- tured so that, in addition to receiv- ing notes, selling shareholders who continue to participate in the compa- ny's management can receive sizable "synthetic equity," which is economi- cally equivalent to stock but without the voting and control attributes. As a fi nancial matter, if an individual has just under 50% "synthetic" in the tax-free ESOP setting, it is worth more than 100% in the fully taxable, non-ESOP situation. 5. Shares are allocated to participant accounts over time and, when they leave the company, the participant receives cash equal to the value of the allocated shares to the extent that he or she is vested. 6. e employees do not own the ESOP shares; the shares are owned by a trustee for the benefi t of the employees. e board and manage- ment continue to run the company — just as before the ESOP. 7. In short, the ESOP provides liquid- ity to the former owners, the board/ management continues to run the company and the employees receive a tremendous benefi t — all paid for by tax savings. 8. e company is healthier for the long term as it enjoys greater cash fl ow as a result of being tax free. Employee-owned companies have several advantages over competitors: enhanced recruiting and employee retention, statistically better performance than their peers and healthier cash fl ows that enable them to weather downward cycles in their respective industries. For companies looking to grow through acquisition, there's an immediate value for each acquisition as the profi ts attrib- uted to the newly acquired company are also no longer subject to income taxes. Also, debt becomes cheaper since prin- cipal is paid with pre-tax dollars (this means that when a company borrows $1 million, it only has to make $1 million to repay debt — in the non-ESOP case, it would have to make roughly $2 million). Since Maine is one of the most highly taxed states, an ESOP is a par- ticularly compelling option. B H is a partner at Bellview Associates in Ellsworth. He c a n be r e a ch e d a t @ . Evaluate an Employee Stock Ownership Plan H OW TO Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of Since Maine is one of the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed the most highly taxed states, an ESOP is a particularly compelling option. Frequent heating system repairs last winter? Consider an upgrade. Find out more about instant discounts natural gas, oil, and propane heating systems at efficiencymaine.com 866-376-2463 Invest in high-efficiency heating systems and controls with help from Efficiency Maine

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