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Is Your Company Too Small for an ESOP?

Posted by Corey F. Schechter | Jul 05, 2017 | 0 Comments

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Employee Stock Ownership Plans (ESOPs) offer a number of advantages for business owners, employees, and the company overall. However, some small businesses may consider themselves too small to justify the costs of transitioning to an ESOP company. A direct sale to key employees may be a way for some small companies to gain some ESOP-like advantages without using a formal ESOP.

An ESOP is a qualified retirement plan that invests primarily in employer securities. Eligible employees are provided a stock ownership interest as a benefit of working for the company. Advantages of an ESOP include the ability to maintain corporate culture while providing employer-funded retirement benefits.

Smaller companies may find it difficult to transition their company to an ESOP. There may simply not be enough employees to fund a purchase of the company. In a recent article, selling a small company to one or more select employees has been termed “ESOP Light.” However, selling your company to employees directly is not an ESOP. Even without the specific tax advantages of a formal ESOP, selling a company to employees directly does offer some of the benefits that a small business is looking for when considering a true ESOP.

Selling to employees carries a number of benefits. This includes maintaining a level of confidentiality in the business, experienced employees are already familiar with the business, and continuity is a sign of stability for customers and vendors. However, selling a small company to employees also has some drawbacks.

In a small company, employees may not have enough money to pay fair market value for the company. Without experience in business transfers and finance matters, employees may be hesitant to put their financial resources into the company. It may also take longer to transition a small company to employee ownership.

Before transferring equity in a company to a single or small group of employees, owners have to consider how transferring ownership interest can impact the business, owner, and employees. Shares of a company that are given to employees or sold at a reduced cost may be taxable compensation to the employee at the difference between the price paid and the stock's fair market value. The employer may also be required to pay payroll taxes on the compensation. However, with proper business counseling, costs and taxes can be minimized.

If the employees do not have enough cash or credit to finance the sale, the employer may have to set up a fund that will be able to purchase the company after a defined period of time. In order to avoid additional FICA and income taxes, contributions to the fund may be made through bonuses, raises, or other compensation the employee would have otherwise received. This fund can be used to purchase the company from the owner.

If you have any questions about your small business exit strategy or whether an ESOP is right for you, Butterfield Schechter LLP is here to help. We are San Diego County's largest law firm focusing its law practice on employee benefits, business, and tax law. Contact our office today with any questions on how we can help you and your business succeed.

About the Author

Corey F. Schechter

Corey Schechter practices in the areas of Employee Benefits, Employee Stock Ownership Plans, Pension and Profit Sharing Plans, ERISA, ERISA Litigation, Business Law, Qualified Domestic Relations Orders (QDROs), and Employment and Labor Law.

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Retirement Plans

We help establish a customized plan that meets regulatory requirements as a tax qualified plan. Following implementation, our attorneys can assist clients and their plan administrator with regular reviews and updates to help with regulatory compliance for the plan's operation, and continued effectiveness in meeting the client's specific goals.

ESOPs

We are dedicated to employee ownership. When you come to us for ESOP services, you receive influential legal counsel who stand beside you to help you stay informed, in compliance, and abreast of the latest developments-all to help you realize your plan goals as fully and effectively as possible.

QDROs

A QDRO is a specially designed court order that is required for the division of retirement benefits in a family law case. Many family law attorneys do not possess the expertise necessary to divide retirement benefits or stock options upon divorce. We have extensive experience in dividing qualified plans, government plans, IRAs and stock options between the employee spouse and non-employee spouse.

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