By Nicholas W. Stuller
“The best-kept secret in the United States Tax Code that can positively impact a business owner are ESOPs…” says Don Israel, the co-founder of New York based Benefit Concepts Systems, Inc. He and partner Dave Weinstock started the firm in 1984, and although Don is a CPA and teaches continuing education for CPAs, his focus is on full-service ESOP consulting. For full disclosure, I hired Don and his firm in years past to set up an ESOP, but I am not a current client.
ESOPs are an amazing way for a small business owner to cash out part or all of his or her business, and financial advisors play an important role in the process. They are very complicated, however, which is one of many reasons why even sophisticated business people are not aware of them. First, let’s discuss the benefits of an ESOP. This unique retirement plan allows a privately held business owner to sell their company, or a part of it—as little as 30 percent of it—and never pay capital gains taxes on the sale.
The owner is essentially selling the company to its employees. The employees do not write a check for the shares—rather, a trust is set up and money is borrowed based on the company’s profitability. The employees get the stock for free in a special, additional retirement account. For the business owner, it can be a huge relief that they have a friendly buyer and don’t have to pay an investment banker, and as long as the firm is sold for its fair value, as determined by an independent valuation firm. Also, the seller can maintain management control of the company, which can be a terrific boon for companies that have multiple generations working there. According to industry statistics, ESOP companies grow between 8 and 11 percent faster than non-ESOP companies, the underlying belief is that employees who are now part owners are more motivated.
Financial advisors play a vital role in the process, because in order for the seller to qualify for tax free status, they must reinvest the proceeds into what is called a qualifying 1042 transaction. Advisors that are expert in these securities are needed, and for example, UBS has a group that is one of the preeminent groups in the country. These securities are usually very long-term bonds with a forty-year or longer maturity issued by blue chip companies with excellent credit. They normally can be highly margined, meaning the seller of the company can get almost all the cash from the sale to use as they see fit.
ESOPs are very complicated, and experts like Don—a benefit plan consultant well versed in ESOPs—as well as attorneys, are needed to implement these plans. However, if the seller’s firm qualifies, these are exceptional programs that benefit the seller and the employees alike. One would think that for the subset of investors who are business owners, that the vast majority would at least be aware that there are advisors who cater to small business owners—or be aware of tools like ESOPS—given the dramatic benefit they offer.
This story first appeared in my book THE TRUTH SHALL SET YOUR WALLET FREE: Secrets to Finding the Perfect Financial Advisor, published in 2018 by Post Hill Press. In 2020 Benefit Concepts Systems, Inc. was acquired by Blue Ridge ESOP Associates.
Nicholas W. Stuller is the Founder and CEO of MyPerfectFinancialAdvisor the premier matchmaker between investors and advisors using personalized data, proprietary algorithms, and deep industry experience.