2. Partner Conference 2014
What is an ESOP?
• An Employee Stock Ownership
Plan (ESOP) is a qualified defined
contribution retirement plan that
is designed to invest primarily in
employer securities
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4
1. Company sets up ESOP Trust
2. Company makes annual tax-deductible
contributions in cash or stock to ESOP
3. Cash used to buy stock from current
shareholders
4. Shares allocated to employee accounts within
the ESOP based on salary. ESOP holds stock for
employees and annually notifies them how
much they own and how much stock is worth.
Employees receive stock or cash after they
retire or leave company, a vesting schedule
applies
Source Morgan, Lewis
Non – Leveraged
Employees
ESOP
(1)
Company
Shareholders
2
3
4
5. (1) Lender lends to company
(2) Company lends to ESOP
(3) ESOP buys stock from existing shareholders
(4) Company makes annual tax-deductible contributions to ESOP.
(5) The ESOP then in turn repays lender
(6) Employees receive stock or cash when they retire or leave (vesting applies)
Source Morgan Lewis
Leveraged ESOP
Lender
Cash
1
2
4
Cash
Stock
3
Shareholders
ESOP
Company
Note
2
6
Stock or Cash
UP-FRONT FLOWS
FUTURE FLOWS
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ESOPs - Advantages
• Provides ownership mentality for employees which could
result in increased productivity
• Provides for the continuity of the company and the employees
• Can be leveraged
– Possible business succession tool
– Allows seller to sell in stages, providing a gradual withdrawal while
allowing heirs, key employees or others partial ownership interest in
company
– Can provide tax advantages to corporation and selling stockholder
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ESOPs - Advantages
• Can be leveraged
– Creates market for stock of a closely-held company
– Creates a ready buyer for company and allows business to be sold on
owner’s terms
– Can obtain tax deductible financing for corporate expansion including
acquisition of new company assets
– Can be used to finance mergers and acquisitions with tax deductible loans
to buy stock
8. Partner Conference 2014
ESOPs - Disadvantages
• Complicated with high start-up costs compared to other plans
• Loan repayments for a leveraged ESOP create an annual
contribution obligation
• Only allocation methods allowable are pro-rata. ESOPs can not
be cross tested or integrated
• Owner must adjust to sharing ownership with the employees
• Increased fiduciary liability
• Participant account balances are not diversified initially
• If the company fails……
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Key Words
Business Continuity
Share ownership or equity
Financing needed for merger,
acquisition or equipment
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What is a KSOP?
• A KSOP is a term of art for an ESOP that
includes a 401(k) feature
• KSOPs may be invested in employer stock in
elective deferral accounts, matching
accounts, employer discretionary accounts or
any combination of the three
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Advantages of a KSOP
• A private company wants to make matching contributions in
employer stock under an ESOP and not be subject to a duty to
diversify plan assets
• The employer wishes to use matching contributions to repay a
securities acquisition Loan.
• The ESOP would otherwise be a frozen or terminating plan,
due to ceasing contributions; and the employer wishes to add
the 401(k) component so that the plan is active and avoid
accelerated vesting
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Advantages of a KSOP
• The employer wishes to avoid two separate audits, assuming
the employer has more than 100 participants
• The employer wishes to avoid having multiple SPDs,
participant statements and 5500 filings
• The employer is publicly traded and employer stock is readily
valued, purchased and sold, it can be administered in a daily
valuation environment
– BPAS administers company stock in a daily valuation
environment even if it is thinly traded
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Disadvantages of a KSOP
• Combining an ESOP with a 401(k) plan will eliminate the
possibility of using a prototype or volume submitter document
for the 401(k) plan
• Combining the plans does not give the employer any
advantage regarding coverage or nondiscrimination testing.
• Administration of a non-publicly traded ESOP will usually take
longer than a 401(k), thereby slowing down the process for
the 401(k) plan
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Disadvantages of a KSOP
• Drafting the SPD for KSOP in a non-publicly-traded company is
complex and confusing due to the potentially different
distribution and fiduciary rules applicable to each plan
• A 401(k) plan and an ESOP may require two different fiduciary
standards for investment of plan assets
• Matching contributions can be accomplished in a separate
ESOP, even when funded with shares released from an ESOP
loan suspense account, as long as the plan clearly states that
plan to which the matching contribution will be deposited
15. Partner Conference 2014
What is a Multiple Employer Plan?
• A Multiple Employer Plan (MEP) is a plan
sponsored by two or more employers where
at least two of the sponsoring employers are
not members of the same controlled group
or affiliated service group
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Reasons for Adopting an MEP
• A business relationship or common ownership may exist even
though it may not be sufficient to qualify as a CCG
• Employers from an organization or common industry may
have employees who shift from one participating employer to
another
• A leasing organization that needs to avoid violating the
exclusive benefit rule
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Related Employers
• Usually occurs in small plans where two or more businesses
have common ownership but not at a level to qualify as a
controlled group
– Often an association of businesses
• Establishing an MEP may help to control costs by reducing
administrative expenses
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Disadvantages
• The primary disadvantage to a MEP is that a failure of one
portion of the plan can result in the disqualification of the plan
as a whole
• DOL opinions indicate that it is scrutinizing MEPS to ensure
that the employers constitute a bona fide group of employers
– If not, the DOL regards the plan as many individual plans rather
than a single plan
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Treatment of Plan Provisions for MEPs
• Single employer for:
– Eligibility
– Exclusive benefit rules
– Vesting
– Accrual
– Contribution and benefit
limitations
– Form 5500
• Separate plan for:
– Coverage rules under
410(b)
– Top heavy
– Funding for pensions
plans
– Deduction Limits
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What is a Multiple Employer Trust?
• A Multiple Employer Trust (MET) is a vehicle in which the
assets of qualified plans maintained by related or unrelated
employers are pooled for investment purposes. It is organized
in the form of a trust and a bank or trust company serves as
the custodian. The investment manager determines the
objectives of the trust and directs the trustee as to its
investment
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Advantages of a MET
• Offer access to investment managers and opportunities in
specialized areas
• Cost-effective approach to a separately managed account
– Savings obtained through efficient management of larger asset pools
– Reduction in transaction and administrative costs
• Participating plans are afforded simplified reporting of
investment value in the MET on a single line on Form 5500
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Disadvantages of a MET
• Plan fiduciary investing in MET
retains fiduciary responsibility for
that decision
• Investment manager is fiduciary
responsible for performance and
operation of the trust
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Case Study #1
• Dr. Jalil contacts you about a retirement plan. She and her
partner want to start saving $50,000 each per year for
retirement. Dr. Jalil’s wife acts as the office manager and comes
into the office bi-weekly to process payroll.
• Dr. Jalil wants flexibility in contributions as he and his partner
have children entering college; they may need cash. He does not
want to add an administrative burden for his wife. His staff is
older than he and his partner. He does not object to making
contributions for his staff as long as he can subject them to a
vesting schedule. He anticipates his staff will remain at the
current level for at least three years.
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Case Study #2
• During a conversation, Jewel, owner of the gym you
frequent, mentions she would like to purchase new gym
equipment. However, equipment is expensive and the
financing will require increased net profits after paying
corporate taxes. Jewel is also interested in establishing a
retirement plan and wants to know if there is a plan type to
help her achieve both goals.
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Case Study #3
• Jeffrey owns a fitness company and wants to encourage his
employees to increase productivity and decrease expenses.
At the same time, he is looking for a higher return on his
investments and would like to save taxes and corporate cash
flow. His key executives would like ownership in the company.
Many of his employees have significant longevity and he
would like to reward them with a piece of the profitability
they helped to create.
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Case Study #4
• Erin, a retired teacher, calls about establishing a retirement
plan. Erin provides consulting services to several educational
organizations and anticipates income from this practice will
be approximately $120,000 (after taxes). Erin did some part-
time consulting for the last three years and earned $72,000
each year.
• She does not anticipate hiring any employees. Erin is 60 years
old and is collecting a pension from her prior employer’s
plan. She plans to continue doing consulting services for
another 5 years.
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Case Study #5
• You meet with Dr. Baker, sole owner of Lakeside Dental. Dr. Baker’s husband
works at Lakeside as Office Manager and processes payroll on Quickbooks.
• Dr. Baker wants flexibility in contributions; she plans to buy new equipment
• She wants to keep plan administration for her husband to a minimum.
• She has two employees in addition to her husband and herself – a hygienist
and a receptionist. Most staff is older than she and she’d like to make a
contribution for them. She does want to subject contributions to a vesting
schedule. She wants to retain her current staff and does not anticipate any
new hires for the next five years.
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Case Study #6
• During a round of golf, your friend, Jim, tells you he wants to
begin saving for retirement. Jim has a small business and his
mother works for him doing payroll and HR functions.
• Jim would like flexibility in contributions and is concerned about
the administrative burden on his mother. Jim has one staff
member, Jack, who is younger than he and he wants to provide
him with a substantial benefit. He would also like to maximize
the benefit to his mother. He would like to subject contributions
to a vesting schedule. One of his goals is to retain Jack as an
employee. He does not anticipate any staff increases in the
foreseeable future
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Case Study #7
• Kevin is the sole owner of Dermagrafix Corporation. He received
two offers by third parties interested in acquiring his company.
Kevin tells you, over coffee, he feels both offers are
unacceptable. The first offer is too low and while the second
offer is acceptable from a price standpoint, the buyer plans to
move the company out of state. Kevin has one son working for
the company, but he is young and relatively inexperienced--not
ready to assume responsibility for corporate ownership. Kevin
also tells you that two of his Senior Executives are capable and
interested in taking over the company, but they don’t have ready
cash to buy Kevin out. Kevin asks you if he should accept one of
the offers or if you have another option that he should consider.
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Case Study #8
• A few years later, you get another call from Kevin. The ESOP you
helped him establish is working well. However, Kevin is
concerned he won’t have enough money saved for retirement.
He has 25 employees now, including himself and his wife.
Everyone is under the age of 30 except Kevin and his wife. Kevin
uses an outside payroll vendor and has an office manager that is
extremely computer savvy. Kevin suspects many of his
employees are not saving for retirement outside of the ESOP and
wants to help them achieve a comfortable retirement. He also
wants to make the maximum contribution for himself and his
wife, which he has determined is $50,000+ per year.
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Case Study #9
• You meet Ben at a cocktail party. He tells you that for the past 18
months, he has owned a sports training facility. He is comfortable
with the revenue and growth of the business and would like to
expand his current employee benefits to include a retirement plan.
Ben doesn’t feel he has the time or expertise to administer the plan.
He has 15 full-time employees and 5 part-time. He can’t afford to
make any employer contributions yet, but hopes to be able to do so in
the near future. Ben is 50 and would like to save as much for
retirement for himself as possible. He is the only highly-compensated
employee. He currently uses an outside payroll vendor that also
provides a platform for health benefits
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Case Study #10
• Moe, Larry, & Curly occupy office space in your building. In the elevator
one morning, you run into Moe. He explains their business to you.
Basically, Moe, Larry & Curly each own 1/3 of two private law firms -
Dewey, Cheatum & Howe and Dewey, Burnham & Howe. You
immediately recognize this makes the law firms part of a brother-sister
controlled group.
• Moe tells you that Curly also owns 100% of a private investigation firm,
Sue, Grabbit & Runne. All three companies are in the same industry
and work out of the same office.
• Moe asks you if there is any way they could establish a retirement plan
to cover employees of the three organizations.
