How to Navigate your ESOP Sale - Bloomberg …...•Installment distributions require single sum...
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Transcript of How to Navigate your ESOP Sale - Bloomberg …...•Installment distributions require single sum...
How to Navigate your ESOP Sale
Seller and Company Considerations
Seller side
• Tax Incentives
– Capital gains on partial disposition of ownership
– Tax deferred sale under Section 1042
• Followed by charitable gift
– Installment sale on seller financed transactions
Seller side
• Investing the 1042
– Qualified replacement property
• Securities of domestic, operating companies– Stock or debt
– Taxable upon DISPOSITION with few exceptions
– Investment period
• 3 months before through 12 months after CLOSING
Seller side• 1042 investment strategies
– How long?• Until death• 10 years or more• Less than 10 years
– For whom?• To live on• To gift to heirs• To gift to charity• To finance other investments
Seller side
• Financing
– ESOP sale
• Subsequent refinancing
– Redemption
• Warrants
Company side• Loan structure
– Under GAAP All ESOP debt hits company’s balance sheet– Offsetting entry is a contra equity account– Consequence
• Negative equity• Consideration for push-down accounting in change in control
transactions– Treatment of resulting goodwill
• Commercial loan considerations• Solvency considerations
Company side
• Cash flow management
– Loan terms
• Length
• Interest Rate– Warrants
• Prepayments
Company side• Cash flow management
– Plan terms
• Allocations– Contributions
– Dividends
• Vesting
• Distributions, including diversification
Company side• Financing distributions to participants for private company
ESOP– Maximize flexibility– Put Option
• 2 events• Prior year appraised value• Installment distributions require single sum cash redemption• Lump-sum distributions permit 5 year note with 6 payments, first
upon execution of put.– Reasonable interest– Adequately secured
Illustration Financing a 1042 Transaction
• 1042 transaction REQUIRES stock to be sold to ESOP
– Seller may be interested in paying tax on a portion of the sales proceeds.
– Financing may be difficult for a 100% ESOP transaction
– Consider partial ESOP sale, partial redemption
Illustration Financing a 1042 Transaction
• Example of partial direct ESOP sale, partial redemption
• Company worth $30 million for ESOP transaction.
• Redemption and ESOP sale happen simultaneously.– Redeem 45% for $13,500,000
– ESOP purchase 55% - $16,500,000
Illustration Financing a 1042 Transaction
Borrow $16,500,000
NOTE
NOTE$16,500,000
$16,500,000
55% of stock
45% of stock for $13,500,000
Subordinated Note for $13,500,000
Warrants
Illustration Financing a 1042 Transaction
45% of stock for $13,500,000
Subordinated Note for $13,500,000
Warrants
Installment Sale
Illustration Financing a 1042 Transaction
$16,500,000
55% of stock
Sale Eligible for Tax Deferral
Why structure this way?
Borrow $16,500,000
NOTE
NOTE$16,500,000
$16,500,000
55% of stock
45% of stock for $13,500,000
Subordinated Note for $13,500,000
Warrants
Common Mistakes1. Prepayment language not negotiated
2. Collateral release miscalculated
3. ESOP S corporation technicalities violated
– 409(p) test
– Cash basis for all accruals to ESOP participants
Common Mistakes4. Interest income in inside loan not reported for
tax
5. S Distributions treated as deductible when applied to loan
6. Book / Tax differences not recognized
7. Alternative minimum tax implications overlooked
Common Mistakes8. Details of 1042 election not satisfied
9. Unique requirements for an ESOP loan not included inside loan documents.
10.Impact on financial statements not considered in planning transaction
