An ESOP Exit Strategy Pays For Itself

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Thu, Feb 28, 2013
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esop exit strategy pays for itselfWe have discussed how incorporating an ESOP in your Business Exit Strategy will Increase the After-Tax Proceeds for the Seller, Providing a Greater Overall Return.  Another compelling reason to incorporate an ESOP in your Business Exit Strategy is that Incorporating an ESOP Increases Company Cash Flow by Eliminating Taxes.  In other words, the tax savings for Incorporating an ESOP in your Business Exit Strategy will provide the funding for most or all of the sale of the company to the ESOP.  

The portion of income attributable to an S Corporation owned by an ESOP is not subject to federal (and most state) income taxation.  S corporation shareholders generally receive dividends each year sufficient to pay their estimated taxes on their portion of the company's income that will ultimately be reported on IRS Form K-1.  The payment of dividends by the company can represent a significant cash outlay for the company. 

In the case of a 100% ESOP owned company, there are no estimated tax payments and therefore there is no need to pay dividends or S distributions of earnings.  This cash flow savings provides a powerful advantage that frees up cash flow and provides most or all of the funding to purchase the company by the ESOP from the business owner.

The following is an illustration of what a typical company would like: 

 

 Before ESOP 

 After ESOP 

EBITDA

 $    1,000,000

 $ 1,000,000

Estimated Taxes (40%)

        (400,000)

 

Estimated ESOP Debt Service *

 

     (586,153)

Available Earnings after ESOP Debt Service

 $       600,000

 $    413,847

* Estimated based on the amortization of $5,000,000 over a 10-year amortization schedule with a 3% interest rate.

In addition to the minimum scheduled payments, some or all of the available earnings after ESOP debt service can be applied to the debt service at the discretion of the Board of Directors.  In the example above, if most of the remaining earnings were applied to ESOP debt service the full loan (and company) could be paid in less than 6 years (and this doesn't even contemplate the impact of the future growth of the company).

The company cash flow savings are one of the reasons that incorporating an ESOP in your Business Exit Strategy is the most cash-efficient and tax-efficient business transition strategy available to business owners.

Benefits of an ESOP as Business Exit Strategy eBook

 

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Topics: Employee Stock Ownership Plan (ESOP), Business Exit Strategy

Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

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