esops for professional service firms
TRANSCRIPT
Presented by:
David B. SolomonLevenfeld Pearlstein, LLC2 N. LaSalle Street, Suite 1300, Chicago, IL 60602Phone: (312) 476-4526 Email: [email protected]
Ronald J. GilbertESOP Services, Inc.251 Albevanna Lane, Scottsville, VA 24590Phone: (434) 286-3130 Email: [email protected]
Robin Jaffe GoebelChemonics International1717 H Street, NWWashington, DC 20006Phone: (202) 955-3454 Email: [email protected]
ESOPs for Professional Service Firms
Employee Ownership Conference
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Types of Equity Compensation Programs
• Stock Options• Stock option plans enable a company to grant employees an option to buy a
stated number of shares at a defined grant price.• Restricted Stock
• Restricted stock is an outright grant of shares to an employee that limits the right to sell, transfer, and/or pledge such stock until the lapse of a vesting period as provided for in the grant agreement.
• Phantom Stock• Phantom stock provides a cash or stock bonus based on the value of a
stated number of shares to be paid out at the end of a specified vesting period.
• Stock Appreciation Rights (SARs)• Stock appreciation rights (SARs) typically provide the employee with a cash
or stock payment based on the increase in the value of a stated number of shares over a specific period of time.
• Equity Value Units (EVUs)• “First Cousin” of a SAR
• Employee Stock Ownership Plan (ESOP)• Qualified retirement plan which holds company stock
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Issues with Various Equity Compensation Programs
• Phantom stock grants, SAR grants and ESOPs generally do not require the employee to make an out-of-pocket investment to obtain the benefits of the equity compensation award.
• For restricted stock, phantom stock grants and ESOPs, the employee is generally insulated against the risk of fluctuation in the stock market since they will receive a benefit regardless of the underlying market value of the company’s stock.
• Stock options (particularly incentive stock options) have favorable tax results for the employees, but may create a less favorable tax result for the company.
• Stock options, restricted stock, phantom stock, SARs and ESOP benefits settled by giving shares of actual stock to the employees may create governance and other issues.
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Why An ESOP as Opposed to Other Equity-Based Incentive Plans?
• Employer-funded benefits (not require personal investment).
• Designed to provide benefits to all employees (not just management).
• Allows employees to defer recognition of taxes on benefits provide by employer.
• Provides employees with a source of funding for retirement.
• Tax benefits to company sponsoring the plan.• Rules governing vesting and limits on distributions
provide a better long-term incentive.• Fiduciary oversight of investment and encourages
better corporate governance practices.
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Other Reasons Why ESOPs Work Well for Service Firms
• No attractive 3rd party offers• Management buyout notice possible• No assets to secure senior bank loan• Culture matters• Desire to perpetuate the company and reward loyal
employees• ESOP transaction may net more to selling
shareholders
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Typical Structure of an ESOP Transaction
SellerESOPBank Company
Loan Loan Purchase Price
Pledge-ESOP Documents &
Other Property
Pledge-ESOP Stock ESOP Stock
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• “Tax-Free” Rollover of Stock Sold to the ESOP• Shareholders of a closely-held C corporation may sell their stock
to the ESOP and if eligible pay no capital gains tax.• The proceeds must be reinvested in the securities of operating
domestic, public or private corporations.• In order to qualify, the stock sold must be held for a three-year
period prior to the sale to the ESOP. At death, under current tax law, the shareholders estate receives “stepped up” bases and the capital gains tax is extinguished. The securities portfolio may be monetized”.
• Tax-Deductible Contributions• Corporate contributions used to purchase company stock or
make ESOP loan principal payments are tax deductible to the corporation.
ESOP Tax Shields
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• Tax-Free S Corporation Income• Income attributable to stock owned by an S corporation ESOP is
not subject to federal tax. This benefit may not be available for smaller companies, due to IRC 409(p).
• Tax-Deductible Dividends When Paid Through the ESOP• Dividends on C corporation ESOP stock that are “passed
through” the ESOP to participants or used to repay ESOP loans may be tax deductible to the corporation. These dividends are not counted in the normal contribution limit of 25% of payroll.
• Allowable and Reimbursable Cost• Allowable and reimbursable ESOP contributions for Federal
Government contractors.• Depending on contract type, ESOP contributions are an
allowable fringe benefit cost fully reimbursable if “room in the rates”
ESOP Tax Shields
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Issues for Service Company ESOP Transactions
Because Service Companies are “Asset Light” may need:• Pledge of personal assets• Personal guarantee• Extended Release formula• Subordinated seller financing• With warrants attached?
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Warrants
• Stock option cousin• Approximates private equity group
mezzanine debt 12%-18% return• 10% to 15% target return• Often worth 1/3 of transaction price in
approximately 5 years
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Seller-Financing Structure of an ESOP Transaction
ESOPSeller Company
Stock ESOP Stock
Note/Pledge of assets Note
*Shares of stock owned by seller redeemed by Company
**ESOP Shares Purchased Directly from Company in exchange for a Note
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ESOP Transaction Structure with other Qualified Plan Assets
SellerESOPCash
StockOtherCompany Retirement
Plan
Rollover of Plan Assets
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Non-Leveraged ESOP Transaction Structure
SellerESOP
Stock
Cash
Company
Cash
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Contributory ESOP Structure
ESOP
*Stock contributed to the ESOP may be newly issued shares or shares previously purchased by Company from other shareholders
CompanyStock
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• ESOP costs can be included as a cost of performing a government contract and reimbursed by the governmental entity
• The contractor’s cost for an ESOP shall be measured by the contractor’s contribution, including interest and C corporation dividends, if applicable, to the ESOP
• Contributions made in company stock shall be based on the market value of the stock at the time of contribution
Additional Benefits of ESOPs for Government Contractors
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Government Contractors (cont.)Challengers of Cost Reimburse Ability
• Calibration of expected cost reimbursement with ESOP loan amortization
• Projecting reimbursable ESOP costs, assigning them to contracts, and keeping competitive rates• It is important to communicate with the
agency’s contracting officer about the ESOP
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Issue for Certain ESOP-Owned Service Companies
Maintaining SBA 8(a) Status• Disadvantaged owner must retain a 51%
ownership interest in the company• ESOP can acquire up to a 49% in the
company and future ESOP stock sales can be planned as the company graduates from the 8(a) program
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History of Chemonics ESOP
1987 Our founder begins to explore the idea of an ESOP• As a way to benefit employees• To create long-term sustainability
2001 Developed the legal frame work and Summary Plan Description
2005 Board agrees to fund the ESOP2009 Our ESOP has 10.24% ownership of the company2011 Become 100% ESOP2012 Funded an International ESOP2015 Received groundbreaking IRS Private Letter Ruling for
an International ESOP
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International ESOP
Who?17 Countries : Afghanistan, Bangladesh, Bolivia, Bosnia & Herzegovina, Botswana, Egypt, El Salvador, Ethiopia, Haiti, Jordan, Mongolia, Nepal, Nigeria, Peru, Uganda, West Bank & Gaza, and Zambia1,100 plus employees
What?25% of payroll which equals a contribution of ~6-8% of salary
Why?One global companySustainability of our long term local national staffSharing in the value and growth of companyRecruitment and retention of talented local staffOverall cost savings
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What Does the ESOP Mean to the Company?
• Cost savings through fringe & employees being fiscally smart
• Staying true to the ideals of our founder• Learning to navigate our new norm of
being a leveraged company• Increased staff satisfaction• Not just another government contractor in a
sea of contractors
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What Does the ESOP Mean to Chemonics Staff?
• Security of not being bought by another company
• Reaping the rewards of their hard work• Additional retirement plan • Truly living our values• Feeling part of a larger team• Increased employee satisfaction with the
company over the years
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What Does the ESOP Mean to Chemonics Staff?
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What Does the ESOP Mean to Chemonics Staff?
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Our ESOP Culture
• Environment of open and honest communication and transparency
• everyone has access to financials• quarterly town hall meetings with CEO and
executive staff• internal portal for feedback and suggestion• annual staff feedback survey
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Our ESOP Culture-Employee Outreach Committee
• EducateFacilitate open lines of communication between plan trustee and employee owners
• Make AwareContinuously teach the impact of being an employee owner on the company’s success
• PromoteObtain feedback on ESOP and communicate to executive management team
• CelebrateRecognize and celebrate the hard work of our employees
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David B. SolomonLevenfeld Pearlstein, LLC2 N. LaSalle Street, Suite 1300, Chicago, Illinois 60602Phone: (312) 476-4526 Email: [email protected]
Ronald J. GilbertESOP Services, Inc.251 Albevanna Lane, Scottsville, VA 24590Phone: (434) 286-3130 Email: [email protected]
Robin Jaffe GoebelChemonics International1717 H Street, NWWashington, DC 20006Phone: (202) 955-3454 Email: [email protected]
Questions
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