Welcome

We are happy to provide you with another edition of M&A Spotlight. With the start of a New Year, we all have a better understanding of some of the variables affecting transactions, taxes in particular, but many questions still remain regarding the capital markets. Proper planning should top the list of New Year's resolutions if you are considering a transaction in the next 24 months. This month's article highlights the need to consider all transaction alternatives which allow business owners to achieve their objectives.

As always, our SC&H Capital team is prepared to invest time getting to know your business. For more information on our services or to schedule a complimentary advisory session, please call me at (410) 785-8049.

Best Regards,
Christopher Helmrath, Managing Director

ESOPs as a Liquidity Event

By Greg Hogan, SC&H Capital

The credit crunch and recession that the United States has endured during the past two years has created a difficult environment for owners of small and middle-market companies to sell businesses and achieve liquidity. Although signs of economic recovery are on the horizon, the M&A markets remain sluggish. Despite the current market conditions, Employee Stock Ownership Plans ("ESOPs") remain a viable strategy for business owners who desire either a full or partial liquidity event.

ESOPs are qualified retirement plans that primarily invest in the stock of the sponsor company and are designed to provide retirement benefits to the sponsor company's employees. Thus, they can be used by a business owner to "create" an buyer of company stock. In addition, ESOPs can create substantial tax benefits for both the corporation and selling shareholder.

There are a number of unique advantages to implementing an ESOP when compared to other exit strategies. Advantages of an ESOP strategy include the following:

Liquidity — An ESOP purchases stock from the existing shareholder(s) much like a traditional strategic or financial buyer. The purchase of stock by the ESOP can be funded by either tax-deductible contributions that are made to the ESOP prior to the purchase (an unleveraged transaction) or with borrowed funds that are paid back by the Company post-transaction (a leveraged transaction). Both the principal and interest portion of the loan repayments in a leveraged transaction are tax deductible up to certain statutory limitations. Note that an ESOP strategy also offers business owners the ability to execute a partial liquidity event wherein only a portion of the Company is sold to the ESOP.

Corporate Tax Benefits — As noted above, the current tax code allows for significant tax benefits for ESOP companies. For a C Corp ESOP company, dividends and contributions made to the ESOP by the sponsor company are tax deductible. For an S Corp ESOP company, the portion of the total income passed through the ESOP is not taxable as the ESOP as the shareholder is not a taxable entity. Therefore, in a 100 percent ESOP owned S Corp the company would operate tax free.

Shareholder Tax Benefits — There are also significant tax benefits for shareholders who sell stock directly to an ESOP. If designed properly, the selling shareholders may elect to defer payment of any capital gains tax, possibly permanently, on the sale of stock to the ESOP. For many private business owners with a low tax basis, the ability to defer, and potentially eliminate, capital gains tax payment is a substantial benefit. Selling stock to an ESOP may also be one of the only ways for a private business owner to realize a stock sale as many strategic and financial buyers prefer to purchase assets, especially in the lower middle market. The ability to sell stock is especially relevant for owners of C Corporations.

Employee Benefits and Retention — All employees of an ESOP company are participants in the plan and are allocated shares in the company through the ESOP annually based on relative levels of compensation. Over time, employees become vested in the ownership of the Company and become increasingly aware of how all employees can help to increase the value of the Company. Therefore, an ESOP can reward employees for their contribution to the profitability of the Company and create a valuable retention tool for Management. Upon leaving the Company, any shares that have been allocated to and vested in an employees' account are then repurchased by the Company.

Ability to Maintain Control — Selling shareholders are often the day to day operators of the business prior to any liquidity transaction. One unique feature of an ESOP transaction is the ability of the selling shareholders to maintain control of the business post-transaction, if desired. Although the Trustee of the ESOP may be a majority shareholder, the day-to-day operations of the business are controlled by the Management team under the oversight of a Board of Directors. There is minimal outside influence on the Company post-transaction and no requirements to change management teams or otherwise influence existing operations. Therefore, selling shareholders can continue to run the business post-transaction while maintaining an interest in the appreciation of the business through a Management Incentive Plan or warrants.

As an ESOP-owned company, SC&H has the real world experience needed to help our clients navigate the unique aspects of an ESOP. We rely on the specialized knowledge of our professionals to serve ESOP clients nationwide, assisting selling shareholders, plan sponsors and trustees in establishing and maintaining well designed ESOPs. Our services cover both the initial ESOP transaction as well as annual compliance issues and include all of the following:

• Pre-transaction valuations and feasibility studies
• ESOP structuring and capital raise
• Fairness opinions
• S Corporation tax opinions
• Annual valuation updates
• ESOP plan audits
• ESOP accounting assistance
• Company sponsor financial statement audits

If you are considering your options for a liquidity event, an ESOP may be the most beneficial vehicle to realize the highest level of after-tax proceeds.

If you, or one of your clients, may benefit from considering an ESOP as an exit strategy, please contact Greg Hogan (ghogan@scandh.com) or Joe Bradley (jbradley@scandh.com) or call (410) 403-1500 or (800) 832-3008.

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This communication does not represent a solicitation of an offer to sell any securities.

Securities offered through Stout Causey Capital Corporation, Member FINRA/SIPC.
Licensed to sell securities in California, Maryland, Massachusetts, Pennsylvania, Virginia and the District of Columbia. SC&H Capital is a registered trade name of Stout Causey Capital Corporation, a subsidiary of SC&H Group, Inc. SC&H Group, Inc. is a member of SC&H Group, LLC.