If the company cannot finance its own buyout, as is usually the case,
it must borrow from a commercial lender. During the repayment process, much of what the company repays to the lender (both principle and interest) is tax deductible. The monies paid to the owner are tax deductible if his company is a C corporation with at least 30 percent of its stock owned by the ESOP.
ESOPs work best at companies that are profitable, because they can more easily generate the cash to pay the owners or the lenders. They should also be of an established size; companies with fewer than 20 people find it challenging to pay the six-figure fees involved in administering one of these programs.
Generally, all full-time employees over 21 can participate in the ESOP, with shares apportioned based on some formula. Often this scheme is relatively straightforward. For example, an employee making $80,000 will receive twice as many shares as an employee making $40,000. An ESOP is not an appropriate mechanism for transferring control to only certain employees or family members.
Employees’ shares vest over time, usually in five to seven years. When an employee leaves, the company is obligated to buy back his shares at fair market value. ESOP companies must set aside significant funds for this purpose. If a company’s value rises significantly, buying back shares from departing or retiring employees can become prohibitively expensive.
Rosen adds that owners are often initially most impressed with the ESOP’s tax benefits, but years later admit that they are happiest knowing that, through employee ownership, their life’s work will endure. Kloke fits this mold precisely. “It’s still there. It’s still an institution,” he beams. “That was part of our motivation. Our name is on the business. We’d like to see it perpetuate and prosper.”
Lee Gimpel is a business and technology writer based in Richmond, Va. lee@gimpelwriting.com
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