| In view of the complexities of the financial | | | | of purchasing shares from separated participants |
| accounting and federal tax rules governing ESOPs, | | | | by the company. This is, of course, an outlay of |
| many ESOP sponsoring companies lose sight of | | | | cash for which no federal tax deduction is |
| larger issues and become buried in the technical | | | | available. When the trust uses deductible cash |
| details of their ESOP and remain fixed on a single | | | | contributions to buy back shares from separated |
| use for their ESOP. Short term benefits of a | | | | participants, these repurchased shares are |
| particular ESOP strategy should not overshadow | | | | reallocated to the remaining participants and the |
| longer term objectives of the company and | | | | process continues as the same shares are |
| alternative uses for their ESOP should be | | | | purchased over and over again by the trust.Buy |
| addressed every couple of years.Typical ESOP | | | | back of shares by the company, however, leads |
| TransactionA very typical scenario in the life cycle | | | | to a reduction or possible total elimination of this |
| of ESOPs is the case where the plan was originally | | | | liability. If this alternative appears to be the most |
| adopted to provide a tax-favored means of | | | | feasible, other forms of incentive compensation or |
| buying out the equity of one or more major | | | | retirement oriented benefit programs should be |
| shareholders in a privately held corporation. This | | | | considered as part of the transition. In other |
| objective can be accomplished using borrowed | | | | words, an overall strategy should be implemented |
| funds from a bank lender or funds provided by | | | | but addressed again as the ESOP mature and the |
| the corporation in the form of a loan to the ESOP | | | | objectives for the ESOP change.ESOP as a Profit |
| trust. Whatever the method, over time the | | | | Sharing PlanContinued federal tax deductible cash |
| buyout is completed, successor management is | | | | contributions can be made to the ESOP and |
| firmly in place, and the equity that was formerly | | | | invested in other securities or used to buy |
| owned by the selling shareholders becomes equity | | | | additional employer company shares, either newly |
| owned beneficially by the plan's employee | | | | issued or from non ESOP shareholders. Launching |
| participants.The Repurchase LiabilityUp to this | | | | into a new round of borrowing is not necessary if |
| point, the corporation has enjoyed the advantage | | | | there is adequate cash in the plan. Cash funding |
| of deducting the yearly contributions made to the | | | | the ESOP will also mitigate the impact of the |
| plan to service the loan to accomplish a well | | | | repurchase liability.Increasing Cash FlowThe |
| defined purpose. For the publicly traded company, | | | | company can merely contribute newly issued |
| there is little downside in such a case since the | | | | shares for which a federal tax deduction is |
| shares that are distributed to retiring and | | | | available. Remaining plan participants receive |
| terminating employees can be sold on the open | | | | additional shares in their accounts from the |
| market. The corporation, in this case, is burdened | | | | forfeiture of unvested shares of separated |
| only with the administrative costs of operation of | | | | employees. If the share values increase over |
| the plan. For the privately held corporation, | | | | time, this is another means of realizing |
| however, the benefits of the original objective | | | | appreciation in the individual ESOP accounts; |
| could all be lost if another strategy is not | | | | however, increasing share values mean increasing |
| implemented.Federal tax rules require that | | | | repurchase liabilities.Importance of a |
| employee participants must be granted a "put | | | | StrategyUnless the ESOP is used by successor |
| option" wherein the company or ESOP is obligated | | | | management to achieve new objectives such as |
| to buy back the shares from separated | | | | funding acquisitions with tax deductible dollars or |
| participants at the then current fair market value. | | | | other strategies that offset the negative aspects |
| Without this provision, the prospect of owning | | | | of the drain on corporate cash flow to fund ever |
| shares in a private corporation with little or no | | | | growing repurchase liability, the long term |
| market would be of nominal interest to most | | | | advantages of winding down the ESOP's share |
| employees under most circumstances. This | | | | holdings should trump the short term advantage |
| obligation to fund the conversion of ESOP shares | | | | of the deductibility of yearly cash contributions to |
| into cash is referred to as the "repurchase liability." | | | | fund repurchases. Recognition of the need to |
| Once this liability is recognized, the company | | | | formulate changing strategies for changing |
| needs to decide whether or not to have the | | | | circumstances should be made when the plan is |
| ESOP or the company repurchase the shares. | | | | initially adopted and ever few years as the ESOP |
| There are pros and cons to both and this will | | | | matures.Jeff Faust has more than 15 years |
| depend on the long term strategy of the | | | | experience in the finance and accounting fields |
| company and the ESOP.Redemption or | | | | with over 10 years in the valuation and stock |
| Repurchase?Shares can be repurchased by the | | | | option industries. He is currently Director of |
| ESOP using cash that was contributed to the | | | | Business Valuations at Greenstein Rogoff Olsen & |
| ESOP on a pre-tax, making this the preferred | | | | Co., a top Bay Area CPA firm. |
| approach. Another alternative is to adopt a policy | | | | |