As hard as it is to sell a construction business outright, it is even more difficult to sell in stages, allowing for a gradual withdrawal by the owner. An employee stock ownership plan, or ESOP, can, in the right circumstances, provide a way to accomplish this goal in a tax-advantaged and non-adversarial manner.
An ESOP allows the company, on behalf of its employees, to use pretax dollars to buy out the owner(s). And, depending on the ESOP's structure, the seller(s) can defer capital gains tax on the sale proceeds — and with certain estate planning can avoid tax altogether.
ESOPs are unique among benefit plans in that the ESOP group can borrow money: A lender loans to the company and the company then reloans the money to the ESOP. The ESOP then buys the selling owner's stock. Of course, the ESOP itself does not have money to repay the loan, so the company makes tax-deductible contributions to the ESOP so the ESOP can repay the lender. In effect, the company can deduct principal and interest on the loan.
The ESOP can borrow money from anyone, including commercial lenders, sellers of stock, or even the company itself, as long as the loan is reasonable and is correctly structured. There is no limit on the term of an ESOP loan other than what lenders will accept (normally 5 to 10 years), and the proceeds from the sale of shares to the ESOP can be used for any business purpose.
The shares of stock purchased by the ESOP are held in a suspense account. As the loan is repaid, these shares are released to the accounts of plan participants. If you're considering an ESOP, the first step is to have an ESOP feasibility study performed by a qualified law firm or an ESOP plan administrator to see if your company meets the various and complex ESOP requirements.
—D.S. Berenson is the Washington, D.C., managing partner of Johanson Berenson LLP (www.homeimprovementlaw.com), [email protected].
This article is for informational purposes only and should not be construed as legal advice.
