What is an ESOP? It is an employee stock ownership plan. These docs are often used to create a market for departing shareholders while giving employees skin in the game. There are also a number of tax benefits that can be realized when ESOPs are available. With increases in the top tax bracket, profits that come from ESOPs mean that the average person can keep more of their money. Not all companies can benefit from an ESOP and there are certainly some pros and cons that must be considered for such a program is implemented. Let’s take a look at those more closely.
The Pros of ESOPs
They are extremely flexible.
Equity holders of ESOPs are able to sell any portion of their ownership rights and simultaneously either gift or sell a portion of their ownership to any other party. They can do so in any arrangement or manner that they choose and they can do it at any time that they choose as well.
Some capital gains taxes can be avoided.
If the equity holder is part of a C-corporation, then there is the possibility that they could defer their entire tax bill from the sale of their ESOP by rolling the proceeds over into a publicly traded security that qualifies. In the US, not all states have adopted this law, however, so this won’t apply every equity holder.
You can still maintain control.
Because you are an equity holder, you can still remain active within a corporation and retain operating control of it thanks to the ESOP. It’s also a good way to avoid certain corporate income taxes. If 60% of a business is owned by ESOPs, then 60% of the corporate income of that business is not taxed and it improves overall cash flow.
The Cons of ESOPs
Equity holders typically finance their own cash payments.
Owners who sell bike ESOP rarely get a full cash payment at the closing of the deal. Equity holders typically have to accept payments over a number of years through the revenues of the business instead of getting payment upfront. This means that equity holders typically bear a certain level of financial risk for several years after a sale takes place.
It can kill cash flow in a hurry.
By definition, an ESOP is a defined contribution to a retirement plan. Because this is the case, there is an obligation to buy back the stock of any employees that choose to depart. If a company has several employees that are at or near retirement age, the cash burden on the company and the ESOP could be too much to bear.
Not everyone can participate.
If the equity holder of an ESOP decides to take advantage of the tax roll options that are available to them, then one quarter of the stockholders and the direct family members of the equity holder have to be excluded from the ESOP. In the past, low income tax rates meant that most sellers are not taking advantage of tax deferral options. With tax bracket percentages increasing across the board, however, this is going to become a growing issue over the next few years unless tax laws change.
ESOPs can provide a lot of financial security. From an American perspective, it is an easy way or someone to pursue their own version of happiness. When the cash flow obligations are taken into account, ESOPs could be the best decision that a company could make.
