Todays Agenda I. The Ownership Transition II. What is an ESOP III. - PDF document

8/30/2016 ESOPs: What Paralegals Need to Know NFPA Annual Convention Burlington, VT October 20-23, 2016 Tabitha M. Croscut, Esq. Steiker, Greenapple & Croscut, P.C. Direct: (215) 508-7709 77 College Street • Suite 2D Burlington, VT 05401 tcroscut@esoplegal.com www.esoplegal.com Today’s Agenda I. The Ownership Transition II. What is an ESOP III. Why Choose an ESOP as a Transition Strategy? IV. How Do ESOPs Work? 1

8/30/2016 T HE O WNERSHIP T RANSITION W HY C ARE A BOUT ESOP S ? P ROBLEM OF L IQUIDITY AND S UCCESSION  All businesses must be or will eventually be sold or transferred  Privately held companies have no ready market  Sales or transfer approach should be based on shareholder goals in the context of achievable alternatives 1

8/30/2016 L IQUIDITY AND S UCCESSION : A LTERNATIVES  External Buyers  Strategic  Financial  IPO  Internal Buyers  Family  Management  Partner (Redemptions & Buy‐Sells)  ESOP  Liquidation W HAT IS A N ESOP? 1

8/30/2016 W HY C HOOSE ESOP: W HAT IS IT ? “Employee Stock Ownership Plan”  Qualified retirement plan under Internal Revenue Code  Regulated by US DOL and IRS • Company‐funded benefit — no employee contributions • Intended to be invested primarily in company stock • Only qualified retirement plan that can borrow money • Tax‐efficient and controlled means of selling stock  ESOP as a shareholder — employees do not have title to shares  W HAT IS AN ESOP?  To Business Owners: …a Buyer of Stock  To Employees: …a Company ‐ Funded Retirement Plan  To Companies: …a Corporate Finance Technique 1

8/30/2016 ESOP E XISTENCE … Applicable in almost all industries — service, manufacturing, professional (engineering and architects) W HY D O B USINESS O WNERS U SE ESOP S ?  Legacy  Employee concern (family)  Control / maintain day ‐ to ‐ day  Diversification / Liquidity  Avoid / Reduce Income Tax (Seller & Company)  Additional retirement plan for employees  Increase employee productivity / employee incentive  Not ready to golf / leave company  Value / purchase price certainty  No ownership transition alternatives – close the doors  Split the baby – division of assets for divorce  Retirement of founder/owner 1

8/30/2016 A Few Core ESOP Advantages and Disadvantages Advantages  Tax efficient  Shareholder &/or Company directed process  Control over timing  Legacy Disadvantages  Complex  Regulated  Often involve Seller notes (e.g. 100% transfer) W HAT LAWS GOVERN ESOP S ? 1

8/30/2016 Governing Laws & Documents ESOP as a Retirement Plan  ERISA & Regulations  Internal Revenue Code & Regulations  Plan Document  Trust Agreement ESOP as a Shareholder  Company Articles  Company Bylaws  Buy‐Sell/Shareholder Agreement H OW D O ESOP T RANSACTIONS W ORK ? 1

8/30/2016 Initial “C” Corporation ‐ Leveraged ESOP Transaction Bank $$ Cash Company  Note & Collateral Note & Pledge of Stock  $$ Cash Shareholder ESOP  100% Company Stock Initial “S” Corporation Leveraged ESOP Transaction $$ Cash Company Bank Cash Note & Collateral Note & Pledge ~100% Stock Company Stock of Stock Stock Cash & Sub. Note Cash & Sub. Note Shareholder w/Warrants ESOP 1

8/30/2016 ESOP Loan Repayment Contributions or Contributions or Dividends Contributions or Dividends ($$$) ($$$) Dividends ($$$) Company ESOP Loan Payments ($$$) Loan Payments ($$$) Loan Loan Payments Payments ($$$) ($$$) Release of Shares Pledged as Collateral and Share Allocations to Individual ESOP Accounts Bank and/or Shareholder T AX -D EFERRED L IQUIDITY TO S ELLERS IN ESOP T RANSACTIONS 1

8/30/2016 IRC § 1042 R OLLOVER R EQUIREMENTS FOR C APITAL G AINS T AX D EFERRAL  Must be a C corporation  Reinvest in Qualified Replacement Property (QRP)  ESOP must own 30% of company  Minimum of 3‐year holding period  “ Best ” stock (voting)  15‐month reinvestment window of proceeds T HE ESOP AS A R ETIREMENT P LAN 1

8/30/2016 ESOP O PERATIONS : P ARTICIPATION & A LLOCATIO NS  Who can Participate in the ESOP?  1,000 hours and age 21 (outside limit)  Who can receive an “ allocation ” in the ESOP?  Employed on last day of PY/FY AND 1,000 hours  Allocation Formula • In proportion to annual compensation [see next slide] • Also points formula optional (not safe harbor) ESOP Operations: Allocation Example Shares purchased by ESOP 6,000 shares Allocation period 20 years Shares Allocation Allocated in W ‐ 2 Pay Percentage 1st Year Employee #1 $25,000 23% 68.18 Employee #2 $35,000 32% 95.45 Employee #3 $50,000 45% 136.36 $110,000 100% 300.00 1

8/30/2016 ESOP O PERATIONS P OST ‐T RANSACTION : V ESTING & D ISTRIBUTIONS  What does an employee get if they terminate? 1. Vesting 3 year cliff or 6 year graded (0%, 0%, 20%, 20%, etc.) • Non‐vested shares are forfeited • 2. Timing of Distributions i‐ Year after death, disability or Normal Retirement Age ii‐ Sixth year after “other” termination 3. Form of Distribution Cash or Company Stock (immediately redeemed) • Lump Sum or 5‐year annual installments • O NGOING ESOP I TEMS P OST - T RANSACTION 1

8/30/2016 O NGOING ESOP I TEMS P OST ‐T RANSACTION  Annual appraisal update  Annual recordkeeping and administration  Repurchase obligations  Communications training and education  Legal compliance  Audit for larger plans W HY C HOOSE ESOP: W HAT M AKES A G OOD ESOP C OMPANY ? If the company is profitable and growing  If the company has debt capacity it can dedicate to funding an  ESOP over and above other reinvestment (not overleveraged) If the company can finance its own growth  If there are enough employees and thus payroll over which the  ESOP costs can be spread If the blend of share allocations and value trajectory results in an  acceptable/appropriate stream of benefits If the company could benefit from a broad‐based ownership plan  If the company has a strong management team  1

8/30/2016 Steps in an ESOP Transaction • Feasibility Study (Transaction Analysis) • Financing • Appraisal • Estate Planning • Plan Design • Legal Documentation • Closing • IRS Determination Letter on ESOP Who might be involved? • ESOP Trustee – independent/external • Financial advisor to seller(s), company, ESOP Trustee • Valuation • Cash flow analysis • Proceeds analysis (cash, principal, interest, warrants, etc…) • Banking Team • Legal representation for seller(s), Company, ESOP Trustee • Corporate, ESOP, Estate Planning, etc… • ESOP Third Party Administrator (TPA) • Accounting Firm (analysis / audit) • Investment Banker • Insurance Broker 1

8/30/2016 P RACTICAL ESOP I SSUES F AMILY L AW & ESOP S Qualified Domestic Relation Orders (QDROs)  What is it?  What’s required?  What’s best practice procedure?  Key terms  ‐ Alternate Payee Liquidity for splitting Assets  1

8/30/2016 E STATE P LANNING & ESOP S Value Implications  1042 Opportunity  Warrants – Dynasty Trust  Equalize  C ORPORATE L AW & ESOP S ESOP as a shareholder  Sale transactions – restrictions on ESP representatives and indemnity  ‐ FMV State ‐ Fairness Opinion Other Non‐ESOP shareholders  Pass‐through voting – merger, sale of assets, recap, consolidation, and  dissolution (not sale of stock) Unallocated/Suspense Shares  C‐Corp Bylaws/Article Restriction to permit cash on to distributions  Releases – ESOPS cannot release “p” claims  1

8/30/2016 B ANKING LAW & ESOP S Collateral  Limitations on security  Covenant for X – ESOP add back  Cannot get ESOP Valuation  R ESOURCES Esoplegal.com/SESAdvisors.com  NCEO.org  Esopassociation.org  1

8/30/2016 QUESTIONS Tabitha Croscut, Esq. Tabitha is the managing shareholder of Steiker, Greenapple & Croscut, P.C., a national law firm with a focus on Employee Stock Ownership Plans (ESOPs) as succession and employee compensation strategies. In addition to counseling clients regarding transactional, compliance and fiduciary issues with respect to their ESOPs, she has represented companies, sellers and internal and external trustees in ESOP transactions ranging from under a million dollars to over four hundred Managing Shareholder million dollars. She is a frequent speaker at ESOP conferences Steiker, Greenapple & nationwide and presents regularly on how ESOPs can be an effective Croscut P.C. exit or transition planning tool for owners of closely held businesses. Tabitha serves as the President and a Director for the Vermont Contact Information: Employee Ownership Center (VEOC), is an active member of The Phone: 215-508-1500 x214 ESOP Association and the National Center for Employee Ownership E-mail Address: (NCEO), and serves on the Board of Trustees for the Employee TCroscut@esoplegal.com Ownership Foundation. Office Addresses: 77 College Street Since 1987, SG&C attorneys have been involved in hundreds of ESOP Suite 2D transactions nationwide, providing legal advice on employee ownership Burlington, VT 05401 matters for corporations, business owners, lenders and ESOP 360 Route 101, Suite 1 fiduciaries. Bedford, NH 03110 Visit our website at: www.esoplegal.com 1