Q. Just bought the company. How soon can I install an ESOP?
A. You can install an ESOP whenever you wish, however, you must own and operate the business for at least three (3) years before you can take advantage of the 1042 Rollover and differ the capital gains tax.
Q. Do my employees who participate get stock they can sell to whomsoever they wish?
A. No. Upon receipt of their stock when they exit the company, they must sell it back to the company or the ESOP, at the most recent ESOP appraisal share value.
Q. Why were my attorney and my CPA less than enthusiastic when I mentioned an ESOP to them?
A. Because ESOPs are a complex, highly specialized area of the law and most attorneys and CPAs are not very well informed on ESOPs.
Q. How long does it take and how much does it cost to set up an ESOP?
A. Normally setting up an ESOP takes several months, but we have seen one completed in a few weeks, especially if there is a compelling reason, such as a big tax saving deadline for the company.
The cost is based on the fees of the attorney preparing the ESOP documents. We have seen costs as low as $25-30,000 and as high as $80–100,000. The fees escalate when you have the attorney do various extra work, some of which can be done by you in your office. While that may seem like a considerable size fee, when you consider the savings in taxes (which can amount to millions), it is a very small price to pay for the savings. The ESOP attorney fees cover documents that provide substantial tax savings to the client. Most of our clients are happy to pay attorney fees, when they save many hundreds of thousands (or more) dollars. (Compare this with the brokerage commission on an outright sale to a 3rd party. And then add paying the capital gains tax. You will learn that the legal fees of an ESOP transaction are much less that paying a broker’s commission plus capital gains tax.)
So far as our appraisal fee for doing the required appraisal work for the actual sale of shares to an ESOP, it will vary in the range of $10,000. The only other fee we collect is a one-time fee for a Fairness Opinion that is furnished to the Trustee of the ESOP Trust at the time the ESOP buys shares. We advise the Trustee that the pending transaction is “fair” to the participants and that the ESOP is paying no more than Fair Market Value for the shares it plans to buy. Our fee for this is usually only $2,000.
Q. Can my key people get bigger shares of the ESOP than other participants?
A. Since a participant’s share is based on her/his gross income, a key employee who presumably is higher paid will earn a larger portion of the ESOP shares. In addition, separate stock options and warrants can be issued, so that a key employee will have extra incentives.
Q. I understand that an ESOP will promote loyalty and help produce increased profits. What other benefits are there?
A. Several of my clients tell me that it is a very big help in recruiting desirable employees. When a candidate looks at other opportunities where there is no ESOP, they recognize the long-term benefit of ownership in the company where they help make it profitable.
It helps keep a good employee from looking elsewhere for another position. Being a long-term employee in an ESOP company pays off. A secretary earning $40,000 per year can expect her stock to be worth several hundred thousand in 15-20 years depending on the profitability of the company.
Q. How small is too small for an ESOP?
A. On the ESOPs page of this site there is a comprehensive answer to that question, written by Mr. Cory Rosen, the Director of the National Center for Employee Ownership (NCEO) in Oakland. We suggest you read Mr. Rosen’s informative answer to the question.
Q. After establishing an ESOP if I wish to sell my business to a 3rd party buyer, can I do it?
A. YES, you can do it subject to a number of guidelines, one of which is: if the ESOP owns 50% or more of your company’s shares, the participants must vote to approve such a sale. There are a number of other important conditions that are too lengthy to answer in the space available here. However, please feel free to call me and we can discuss all of them at length so you will be able to proceed with full knowledge of what is required.
Q. What happens if I fail to purchase the full amount of Qualifying Replacement Property within 12 months after I sell my shares to the ESOP? I sold my shares for $3,000,000, but only invested $2,800,000 within the 12-month deadline. Can I invest the $200,000 balance beyond the deadline and still avoid capital gains tax?
A. Sorry no. You cannot enjoy the 1042 rollover privilege on the $200,000 balance. You will have to pay capital gains tax on what that you failed to invest within the 12 months. Federal tax rate is 15% and here in California it is 8.5% that will cost you $31,445 total if you live in CA. Who was your ESOP financial advisor? They were not doing their job and you missed the boat.
Q. Why don’t I have to pay capital gains tax on the proceeds from the sale?
A. The legislation passed in Congress nearly 30 years ago gave shareholders the privilege of postponing or eliminating capital gains tax as an incentive to form an ESOP which enabled the employees to gain ownership in the company where they worked. Congress recognized that social security benefits would not be enough and added ESOP benefits to the employees' possible retirement income.
