Leveraged ESOP Flashcards
(14 cards)
What is a Leveraged ESOP?
A Leveraged Employee Stock Ownership Plan (ESOP) is a qualified retirement plan that borrows money to purchase company shares, mainly as an exit strategy for business owners and to transfer ownership to employees
What are the main purposes of a Leveraged ESOP?
To facilitate the sale of a business for liquidity or succession planning (exit strategy)
To raise capital for acquisitions, refinance debt, or buy back shares
Who are the key parties in a Leveraged ESOP transaction?
Principal Stockholder(s): Selling owner(s)
Company: Borrows funds and guarantees the loan
ESOP Trust: Purchases shares with loan proceeds
Lender (Bank): Provides the loan, secured by company assets and purchased shares
Employees: Receive allocations of company stock as the loan is repaid
How does a Leveraged ESOP work?
The company borrows money from a lender, often using company assets and ESOP-owned stock as collateral.
The company loans the funds to the ESOP trust, which buys shares from the owner(s) or the company.
Shares are held in a suspense account and gradually released to employee accounts as the loan is repaid.
What is the role of the ESOP Trust?
The ESOP trust acts as the purchaser of shares, receives loan proceeds, and allocates stock to employees as the loan is paid down
How are shares allocated to employees?
As the ESOP loan is repaid through annual, tax-deductible company contributions, shares are released from the suspense account and allocated to employees, typically based on compensation or tenure
When do employees receive ESOP benefits?
Employees receive distributions of company stock upon retirement or termination of employment
What are the main advantages of Leveraged ESOPs for employers/owners?
Tax-advantaged exit strategy (sellers can defer or reduce capital gains taxes)
Company contributions to the ESOP for loan repayment are tax-deductible (principal and interest)
Can raise capital for acquisitions or other corporate purposes
Employee ownership can increase productivity, profitability, and retention
What are the main advantages for employees?
Retirement benefit linked to company performance
Sense of ownership and alignment with company goals
What is unique about ESOPs compared to other retirement plans?
ESOPs are the only qualified retirement plans allowed to borrow money to finance stock purchases
What are key financial considerations for companies using Leveraged ESOPs?
Must have sufficient and stable cash flow to support loan repayment
Transaction structure (internal/external loan, seller notes) can vary
Leveraged ESOPs increase company debt and reduce equity in the short term
What is the typical collateral for a Leveraged ESOP loan?
Company assets and the ESOP-owned stock
What triggers the release of shares from the suspense account in an ESOP?
Repayment of the ESOP loan through company contributions
What should CFP candidates focus on regarding Leveraged ESOPs?
Understand the unique features: ESOPs as qualified plans that can borrow, their use as exit strategies, and the tax benefits for sellers and the company
Know the basic structure, parties, and key advantages.
