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Ownership ("The Pros and Cons of The ESOP Exit Strategy" continued from page 36) whatever the employees want it to do." Marsteller says owners often have a desire to keep the business in the community and they stand a better chance of doing that with an ESOP. Some owners may want to continue on in some role at the company, while others want to be completely removed. Gibson added, "Dealers need to have full understanding of what the reality looks like after the transaction." This includes how the company will manage the debt moving forward. According to J. Michael Keeling, president of The ESOP Association, there are approximately 10,000 companies nationwide that are employee-owned in varying degrees. The vast majority are privately held, and the number has held steady over the years. Not all ESOPs are 100 percent employee owned, but the portion of stock is growing. Among ESOP Association ESOP Fables Debunked No. 1: The company has to open up its complete financial records to employees. It is a common misconception that ESOP companies must disclose their financial statements, officer salaries, share ownership structure, and other information to ESOP participants. There is no requirement to do so. Most ESOP companies provide some form of financial disclosure and are required by law to provide individual benefit statements to shareholders. Few provide information on salaries. No. 2: Employees will control the company. Establishing an ESOP does not mean a company has a democratic business model. Company leadership can and should remain in place. While in nonpublic ESOP companies voting rights on shares allocated to ESOP accounts must be "passed through" to ESOP participants for votes on major corporate matters, other decisions can be voted by a named fiduciary or designated in the plan. No. 3: I don't have the right type of company for an ESOP. ESOPs are available to companies small and large, public and private. More important is that the business has strong cash flow, a history of increasing sales and profits, and is willing to provide employees with equity. No. 4: It's too expensive to set up an ESOP. It's true there is legal work at the onset to form an ESOP, annual costs for evaluation and for additional reporting. However, these costs are typically less than perceived and offset by the significant tax benefits of an ESOP. members, the average size of the ESOP is about 67 percent. According to Keeling, ESOPs have four key tax advantages. "With an ESOP transaction financed with debt, both the principal and interest are deductible," he said. "An S-Corporation with an ESOP is a tax exempt trust, so you don't pay tax on the ESOP's share of the taxable income," Keeling added. "Tax will be paid by individuals when they leave the company and get a distribution." A 100 percent employee-owned S-corp. pays no corporate income tax. C-corporations can also deduct dividends from their taxes, and if the employees own more than 33 percent of the company, the seller doesn't pay the capital gains tax, as long as they are invested in another U.S. company. Who's Right for an ESOP? Because an ESOP often requires going into debt to ensure the business owner can cash out, businesses need to be in good fiscal condition. "At the end of the day, the company needs to be profitable and needs cash flow," said Marsteller. Most employers with an ESOP have between 50 and 250 employees. "[With] under 25 employees it is going to be very difficult to finance a debt," said Kneeling. The financials need to support the value of the company and what the owner wants to get out of it. Disadvantages to ESOPs include some substantial reporting requirements including annual valuations, audits by the IRS and Department of Labor (if you have more than 100 participants). More legal counsel is usually required. From the owner's point of view, the valuation of the company is likely to be lower than what a strategic buyer would pay. "It is hard to sell 100 percent of your company to an ESOP and get all of your cash up front," said Gibson. "It is more likely to [yield] a third up front." Gibson suggests finding an advisor who can help guide you through the process but doesn't believe it is any more difficult than any other sales option. Marsteller agrees that good financial counsel for the future profitability and cash flows of the business is key. One of the more common misconceptions is that becoming an ESOP somehow means the company will be managed in a democratic style. The reality is that the owner can set up the board and determine how the company will be operated. The trustee of the ESOP is responsible only for representing the interests of the employees. "I've had a lot of naysayers tell me not to do it, but I don't discourage too easily," said McFadden. One of the key tasks for McFadden and ICM in the near future will be finding someone to fill his shoes in the role of president and CEO. The current management team consists of McFadden, the sales and marketing manager, the CFO, and three of the better sales performers in the company. "Over the next three years we will find someone to be trained for the CEO job. I will move up to chairman of the board. I will help when they need me – providing guidance 38 | www.cedmag.com | Construction Equipment Distribution | October 2013 36_ESOP_Feature_KP.indd 38 9/26/13 3:30 PM