Seller Financed ESOP
A Seller Financed Employee Stock Ownership Plan ("ESOP") is very similar to a "Leveraged ESOP" with one exception, the seller becomes the bank and the company makes note payments to the seller not the lender. What is important to realize here is that if structured properly, the seller can receive the principal from the Company "tax free." Or stated another way, if properly structured the seller can still take advantage of IRC 1042 making the seller financed ESOP a very powerful finance tool. Here are the steps:
- Lender funds a "one day loan" in the amount of the ESOP transaction
- The Company loans the same amount to the ESOP as outlined on our leveraged ESOP page.
- ESOP purchases stock from selling shareholder, the Company, or a combination of both, depending on the determined structure of the transaction.
- Seller retains 10% of the proceeds and makes a loan to the Company for 90% of the proceeds.
- The Company takes the money received from the sale of treasury stock to the ESOP, if any, along with the proceeds of the loan from the shareholder and immediately repays the lender, usually within two hours of receipt of the loan proceeds.
- The seller then uses the 10% retained to purchase floating rate notes in the amount of 100% of the proceeds received. The 90% represents a leveraged investment as often is done in conjunction with any IRC 1042 transaction.
- The seller of stock receives principal and interest payments from the Company with the interest being taxable to the seller and the return of principal being received with no tax consequence to the seller.
- Seller financed note can be "refinanced" with a third party lender at any time during the "payback period" should the Company and the seller decide to do so.
This transaction accomplishes the following for the affected parties:
Lender
- Cooperates with a customer and then has the possibility of future business with that Company for normal operating needs, or to "take out" the seller at a later date.
- Made a loan with a near simultaneous pay-off for a profitable fee.
Company
- The Company has risk reduction if a unforeseen economic downturn should occur. The seller will be a more understanding lender and can easily refinance or adjust payments during difficult times
- Loan terms can be more flexible with the seller than would normally be allowed by a third party.
- No ongoing lender oversight, meaning: no loan covenants, no loan committees,or no loan approval due diligence
- This transaction will not affect the Company's ability to borrow money for normal operating needs if this loan is subordinated to the lender. The Company and seller decide that at the time of applying for the third party loan.
- Cost of this transaction is significantly lower than a traditional third party leveraged transaction.
- All costs are tax deductible to the Company.
- There can be NO margin call on the FRN's, this is a substantial benefit to both the Company and Selling Shareholder.
Shareholder:
- Remains in "control" of the Company so as to assure payment from the Company.
- No permanent need for an outside lender.
- Shareholder takes full advantage of IRC 1042 and defers the capital gain tax on the stock sale.
- There can be NO margin call on the FRN, as outlined above.
- More favorable tax treatment for interest vs. wages (after tax income usually increases).
- Loan will have "change in control" provision that assure payment if the Company is sold to a third party.
- Principal repayment can be invested in a portfolio of stocks and bonds without triggering tax under IRC 1042.
- Interest rate often fixed or variable at above then market rates.
Under the right circumstances this transaction sets in motion the process for an orderly transfer of ownership, while minimizing the impact on the Company, and giving the seller the most flexibility in the process. What is required is a team with deep experience in ESOP implementation and design. ATICG is an expert in this area and can develop a transaction that meets all of your financial goals and management objectives.
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