If the phone ain’t ringin’, maybe there’s a reason. The biggest
competition to Berkshire
or the Koch’s for buying out attractive private businesses isn’t each other, or private equity groups, it’s employee stock ownership plans (ESOP’s) largely funded by …us!
Especially for about the past fifteen years we, meaning our duly elected representatives in Congress, have determined that it is good public policy for us to collectively bank-roll employee purchases of private employers – that is, for any good private company worth buying.
We’ll foot the bill, the employees will get the equity. Not only that, but to sweeten the pot to the sellers (the founders, their families, etc), we’ve also added some compelling tax incentives to go this route, including the option to defer capital gains as long as they like.
Plus, they still get to run their companies – and maybe their kids can carry on if so inclined – for as long as they wish, drawing full salary and everything, even after cashing out. Nothing will have changed for them, day to day. Employees won’t have had to put in a dime. But the owners get to pocket what otherwise would have been going to the IRS – for both the company and themselves personally.
Now the key is that it has to be a private company with positive cash flow etc. No turnarounds, no dogs, no dead-men-walking. Get too tricky, like Sam Zell in Chicago, with newspaper and other businesses that aren’t self-supporting, and the tax backlash for failure can be heavy-handed. But those are businesses that shouldn’t be foisted on employees in the first place (and we know are the types of business or industries that wouldn’t have the slightest appeal to Berkshire or the Koch’s – most obviously).
For fundamentally healthy companies, however, ESOP’s can be a tax-funded bonanza for everyone. Anyone thinking of selling to Buffett or the Koch’s would have to be at least looking at the ESOP option.
Now I’m going to over-simplify here, most admittedly, and speak generically (there are a number of alternative courses that might be best depending on specific circumstances). The crux of the deals, though is that employees never have to pay anything for their shares. We (you and I) will handle that.
The owner sells the shares to an ESOP, into a trust (we’ll come back to this). He can take a note, or the company can take on debt an pay him cash, finance assets LBO-style, whatever. For simplicity, let’s say it’s an owner-held note. The company will pay down the note over time. This is where the tax code comes in. For ESOP’s, both principal and interest payments on the note are tax-deductible. Basically, the deal can be structured so that anything that the company would have been paying in taxes in the past now goes to debt repayment – essentially to the owner.
Now if the owner reinvests those payments he receives in a ‘qualified investment’, any capital gains from the deal are deferred as long as that investment is held. Berkshire shares qualify – as do dividend paying stocks, if that’s what’s desired. Or bonds, etc.
Remember that trust we set up to house the company shares?
The employees are the beneficiaries, but the owner – the seller - can decide to be the trustee if he likes – with the authority to vote the shares, appoint company management, and such. It’s him calling the shots as long as he likes, not a Buffett or a Koch. He now essentially kicks those pre-tax earning up to himself, tax-free (ok, indefinitely tax deferred). If the company has a cash pile, or mortgageable assets, company cash or debt proceeds can be used towards (again tax-deductible to the company) pay-down of his note, the proceeds of which of course can be tax deferred.
When we cut through it, the economics of it all is that – compared to continuing to hold the company, and (if a C-Corp) pay taxes at the corporate and personal level, by ceding beneficial ownership, the owner can name his price (subject to review), set his terms to himself including term of the note, interest rates on it, and such, take his payment from what would have been the company’s tax burden, and give himself a tax-deferred ‘dividend,’ in essence. Existing S-corps have their own nuances and benefits (and Zell’s tax mis-steps notwithstanding, more aggressive tax pros can weave between S-Corp and C-Corp status to get the best of both worlds – but that’s digressing too much.)
Now we might think this is pretty slick so far, just as it is, however if there are any who wonder just how far your government might go to further sweeten the ESOP pot, consider this (from Washington Technology, 10/29/12): “one of the huge advantages for government contractors is that ESOP costs are allowable expenses under FAR for those contractors with cost-plus contracts. Therefore, the contributions used to repay stock acquisition debt are allowed to be included in a company’s direct rates. This is a significant benefit to contractors and should not be overlooked.”
I don’t know – to me that sounds like the market value of these private contractors should be pretty rich – especially if our government is willing to step up and shoulder the acquisition costs more than just once.
We should all pat ourselves on the back for doing our part to finance employee ownership of American businesses, and for securing the futures of the founders.
Anyway, any large private company owners out there – if you meet Berkshire’s long-stated acquisition criteria, you might also make an appropriate ESOP candidate. Over 11,000 private companies have taken the plunge, including some sizable private examples right in Omaha.
Awhile back I happened to meet the CPA in NE who specializes in ESOP work -- his clients were throughout the region, mostly in NE. He commented that almost every medium sized town in the state, just about, had one sizable employer in town that had converted to ESOPs; that it especially seemed to be a trend in those towns. In any case, he certainly had a sweet business niche carved out.
So far, we haven’t looked at this from the employee’s point of view. Well at least initially, the value of the company stock they are being given (through that beneficial trust) could be low. Very low. That’s not necessarily a bad thing, considering it’s ‘compensation’, reported at share value when employees are awarded the shares. Again, in our example they aren’t paying anything for the shares – these are a company benefit.
The reason for the low valuation for this fine business, in our example, is the heavy ESOP debt - that huge ‘purchase’ note obligation owed to the seller, representing the market value. Lot’s of debt (owed to the owner), little equity value. Again assuming it’s a healthy business, as that debt is paid down, by us and with our blessing, the value of the equity, those ESOP shares, increases accordingly.
If the business grows, all the better. While employees may not get a lot of cash thrown their way (dividends) for a while, looking long-term, equity (intrinsic value per share) grows with the loan pay-down, and after the owner note is paid off that cash flow can essentially redirects to them and can be pretty nice.
Where the dynamics between the selling owner employees are particularly good, maybe these are the folks who helped get you there and include the future leaders , this can be a nice deal. Everybody wins -- including hopefully us, in a broader societal sense (right?) for our own unselfish contributions to this arrangement. As with any business deals, some might not work out at hoped, but some might be home runs.
So when it’s time to sell, call Berkshire. Maybe also call your tax professionals. See who has the best deal for your situation.
or the Koch’s for buying out attractive private businesses isn’t each other, or private equity groups, it’s employee stock ownership plans (ESOP’s) largely funded by …us!
Especially for about the past fifteen years we, meaning our duly elected representatives in Congress, have determined that it is good public policy for us to collectively bank-roll employee purchases of private employers – that is, for any good private company worth buying.
We’ll foot the bill, the employees will get the equity. Not only that, but to sweeten the pot to the sellers (the founders, their families, etc), we’ve also added some compelling tax incentives to go this route, including the option to defer capital gains as long as they like.
Plus, they still get to run their companies – and maybe their kids can carry on if so inclined – for as long as they wish, drawing full salary and everything, even after cashing out. Nothing will have changed for them, day to day. Employees won’t have had to put in a dime. But the owners get to pocket what otherwise would have been going to the IRS – for both the company and themselves personally.
Now the key is that it has to be a private company with positive cash flow etc. No turnarounds, no dogs, no dead-men-walking. Get too tricky, like Sam Zell in Chicago, with newspaper and other businesses that aren’t self-supporting, and the tax backlash for failure can be heavy-handed. But those are businesses that shouldn’t be foisted on employees in the first place (and we know are the types of business or industries that wouldn’t have the slightest appeal to Berkshire or the Koch’s – most obviously).
For fundamentally healthy companies, however, ESOP’s can be a tax-funded bonanza for everyone. Anyone thinking of selling to Buffett or the Koch’s would have to be at least looking at the ESOP option.
Now I’m going to over-simplify here, most admittedly, and speak generically (there are a number of alternative courses that might be best depending on specific circumstances). The crux of the deals, though is that employees never have to pay anything for their shares. We (you and I) will handle that.
The owner sells the shares to an ESOP, into a trust (we’ll come back to this). He can take a note, or the company can take on debt an pay him cash, finance assets LBO-style, whatever. For simplicity, let’s say it’s an owner-held note. The company will pay down the note over time. This is where the tax code comes in. For ESOP’s, both principal and interest payments on the note are tax-deductible. Basically, the deal can be structured so that anything that the company would have been paying in taxes in the past now goes to debt repayment – essentially to the owner.
Now if the owner reinvests those payments he receives in a ‘qualified investment’, any capital gains from the deal are deferred as long as that investment is held. Berkshire shares qualify – as do dividend paying stocks, if that’s what’s desired. Or bonds, etc.
Remember that trust we set up to house the company shares?
The employees are the beneficiaries, but the owner – the seller - can decide to be the trustee if he likes – with the authority to vote the shares, appoint company management, and such. It’s him calling the shots as long as he likes, not a Buffett or a Koch. He now essentially kicks those pre-tax earning up to himself, tax-free (ok, indefinitely tax deferred). If the company has a cash pile, or mortgageable assets, company cash or debt proceeds can be used towards (again tax-deductible to the company) pay-down of his note, the proceeds of which of course can be tax deferred.
When we cut through it, the economics of it all is that – compared to continuing to hold the company, and (if a C-Corp) pay taxes at the corporate and personal level, by ceding beneficial ownership, the owner can name his price (subject to review), set his terms to himself including term of the note, interest rates on it, and such, take his payment from what would have been the company’s tax burden, and give himself a tax-deferred ‘dividend,’ in essence. Existing S-corps have their own nuances and benefits (and Zell’s tax mis-steps notwithstanding, more aggressive tax pros can weave between S-Corp and C-Corp status to get the best of both worlds – but that’s digressing too much.)
Now we might think this is pretty slick so far, just as it is, however if there are any who wonder just how far your government might go to further sweeten the ESOP pot, consider this (from Washington Technology, 10/29/12): “one of the huge advantages for government contractors is that ESOP costs are allowable expenses under FAR for those contractors with cost-plus contracts. Therefore, the contributions used to repay stock acquisition debt are allowed to be included in a company’s direct rates. This is a significant benefit to contractors and should not be overlooked.”
I don’t know – to me that sounds like the market value of these private contractors should be pretty rich – especially if our government is willing to step up and shoulder the acquisition costs more than just once.
We should all pat ourselves on the back for doing our part to finance employee ownership of American businesses, and for securing the futures of the founders.
Anyway, any large private company owners out there – if you meet Berkshire’s long-stated acquisition criteria, you might also make an appropriate ESOP candidate. Over 11,000 private companies have taken the plunge, including some sizable private examples right in Omaha.
Awhile back I happened to meet the CPA in NE who specializes in ESOP work -- his clients were throughout the region, mostly in NE. He commented that almost every medium sized town in the state, just about, had one sizable employer in town that had converted to ESOPs; that it especially seemed to be a trend in those towns. In any case, he certainly had a sweet business niche carved out.
So far, we haven’t looked at this from the employee’s point of view. Well at least initially, the value of the company stock they are being given (through that beneficial trust) could be low. Very low. That’s not necessarily a bad thing, considering it’s ‘compensation’, reported at share value when employees are awarded the shares. Again, in our example they aren’t paying anything for the shares – these are a company benefit.
The reason for the low valuation for this fine business, in our example, is the heavy ESOP debt - that huge ‘purchase’ note obligation owed to the seller, representing the market value. Lot’s of debt (owed to the owner), little equity value. Again assuming it’s a healthy business, as that debt is paid down, by us and with our blessing, the value of the equity, those ESOP shares, increases accordingly.
If the business grows, all the better. While employees may not get a lot of cash thrown their way (dividends) for a while, looking long-term, equity (intrinsic value per share) grows with the loan pay-down, and after the owner note is paid off that cash flow can essentially redirects to them and can be pretty nice.
Where the dynamics between the selling owner employees are particularly good, maybe these are the folks who helped get you there and include the future leaders , this can be a nice deal. Everybody wins -- including hopefully us, in a broader societal sense (right?) for our own unselfish contributions to this arrangement. As with any business deals, some might not work out at hoped, but some might be home runs.
So when it’s time to sell, call Berkshire. Maybe also call your tax professionals. See who has the best deal for your situation.
