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Presented by:
David B. Solomon
Levenfeld Pearlstein, LLC
2 N. LaSalle Street, Suite 1300, Chicago, IL 60602
Phone: (312) 4...
Types of Equity Compensation Programs
• Stock Options
• Stock option plans enable a company to grant employees an option t...
Issues with Various Equity Compensation
Programs
• Phantom stock grants, SAR grants and ESOPs generally do
not require the...
Why An ESOP as Opposed to Other Equity-
Based Incentive Plans?
• Employer-funded benefits (not require personal
investment...
Other Reasons Why ESOPs Work Well for
Service Firms
• No attractive 3rd party offers
• Management buyout notice possible
•...
Typical Structure of an ESOP Transaction
SellerESOPBank Company
Loan Loan Purchase Price
Pledge-ESOP
Documents &
Other Pro...
• “Tax-Free” Rollover of Stock Sold to the ESOP
• Shareholders of a closely-held C corporation may sell their stock
to the...
• Tax-Free S Corporation Income
• Income attributable to stock owned by an S corporation ESOP is
not subject to federal ta...
Issues for Service Company ESOP
Transactions
Because Service Companies are “Asset
Light” may need:
• Pledge of personal as...
Warrants
• Stock option cousin
• Approximates private equity group
mezzanine debt 12%-18% return
• 10% to 15% target retur...
Seller-Financing Structure of an ESOP
Transaction
ESOPSeller Company
Stock ESOP Stock
Note/Pledge
of assets
Note
*Shares o...
ESOP Transaction Structure with other
Qualified Plan Assets
SellerESOP
Cash
StockOther
Company
Retirement
Plan
Rollover of...
Non-Leveraged ESOP Transaction
Structure
SellerESOP
Stock
Cash
Company
Cash
13
Contributory ESOP Structure
ESOP
*Stock contributed to the ESOP may be newly issued shares or
shares previously purchased ...
• ESOP costs can be included as a cost of
performing a government contract and reimbursed
by the governmental entity
• The...
Government Contractors (cont.)
Challengers of Cost Reimburse Ability
• Calibration of expected cost
reimbursement with ESO...
Issue for Certain ESOP-Owned Service
Companies
Maintaining SBA 8(a) Status
• Disadvantaged owner must retain a 51%
ownersh...
History of Chemonics ESOP
1987 Our founder begins to explore the idea of an ESOP
• As a way to benefit employees
• To crea...
International ESOP
Who?
17 Countries : Afghanistan, Bangladesh, Bolivia, Bosnia &
Herzegovina, Botswana, Egypt, El Salvado...
What Does the ESOP Mean to the
Company?
• Cost savings through fringe & employees
being fiscally smart
• Staying true to t...
What Does the ESOP Mean to Chemonics Staff?
• Security of not being bought by another
company
• Reaping the rewards of the...
What Does the ESOP Mean to Chemonics Staff?
22
What Does the ESOP Mean to Chemonics Staff?
23
Our ESOP Culture
• Environment of open and honest
communication and transparency
• everyone has access to financials
• qua...
Our ESOP Culture-Employee Outreach Committee
• Educate
Facilitate open lines of communication between plan
trustee and emp...
David B. Solomon
Levenfeld Pearlstein, LLC
2 N. LaSalle Street, Suite 1300, Chicago, Illinois 60602
Phone: (312) 476-4526 ...
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ESOPs for Professional Service Firms

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This presentation describes why professional service firms choose an ESOP to implement their goals, including the goal of providing employee ownership, and how ESOPs are implemented by the firm with or without outside financing.

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ESOPs for Professional Service Firms

  1. 1. Presented by: David B. Solomon Levenfeld Pearlstein, LLC 2 N. LaSalle Street, Suite 1300, Chicago, IL 60602 Phone: (312) 476-4526 Email: dsolomon@lplegal.com Ronald J. Gilbert ESOP Services, Inc. 251 Albevanna Lane, Scottsville, VA 24590 Phone: (434) 286-3130 Email: esop@esopservices.com Robin Jaffe Goebel Chemonics International 1717 H Street, NW Washington, DC 20006 Phone: (202) 955-3454 Email: rgoebel@chemonics.com ESOPs for Professional Service Firms Employee Ownership Conference 1
  2. 2. Types of Equity Compensation Programs • Stock Options • Stock option plans enable a company to grant employees an option to buy a stated number of shares at a defined grant price. • Restricted Stock • Restricted stock is an outright grant of shares to an employee that limits the right to sell, transfer, and/or pledge such stock until the lapse of a vesting period as provided for in the grant agreement. • Phantom Stock • Phantom stock provides a cash or stock bonus based on the value of a stated number of shares to be paid out at the end of a specified vesting period. • Stock Appreciation Rights (SARs) • Stock appreciation rights (SARs) typically provide the employee with a cash or stock payment based on the increase in the value of a stated number of shares over a specific period of time. • Equity Value Units (EVUs) • “First Cousin” of a SAR • Employee Stock Ownership Plan (ESOP) • Qualified retirement plan which holds company stock 2
  3. 3. Issues with Various Equity Compensation Programs • Phantom stock grants, SAR grants and ESOPs generally do not require the employee to make an out-of-pocket investment to obtain the benefits of the equity compensation award. • For restricted stock, phantom stock grants and ESOPs, the employee is generally insulated against the risk of fluctuation in the stock market since they will receive a benefit regardless of the underlying market value of the company’s stock. • Stock options (particularly incentive stock options) have favorable tax results for the employees, but may create a less favorable tax result for the company. • Stock options, restricted stock, phantom stock, SARs and ESOP benefits settled by giving shares of actual stock to the employees may create governance and other issues. 3
  4. 4. Why An ESOP as Opposed to Other Equity- Based Incentive Plans? • Employer-funded benefits (not require personal investment). • Designed to provide benefits to all employees (not just management). • Allows employees to defer recognition of taxes on benefits provide by employer. • Provides employees with a source of funding for retirement. • Tax benefits to company sponsoring the plan. • Rules governing vesting and limits on distributions provide a better long-term incentive. • Fiduciary oversight of investment and encourages better corporate governance practices. 4
  5. 5. Other Reasons Why ESOPs Work Well for Service Firms • No attractive 3rd party offers • Management buyout notice possible • No assets to secure senior bank loan • Culture matters • Desire to perpetuate the company and reward loyal employees • ESOP transaction may net more to selling shareholders 5
  6. 6. Typical Structure of an ESOP Transaction SellerESOPBank Company Loan Loan Purchase Price Pledge-ESOP Documents & Other Property Pledge-ESOP Stock ESOP Stock 6
  7. 7. • “Tax-Free” Rollover of Stock Sold to the ESOP • Shareholders of a closely-held C corporation may sell their stock to the ESOP and if eligible pay no capital gains tax. • The proceeds must be reinvested in the securities of operating domestic, public or private corporations. • In order to qualify, the stock sold must be held for a three-year period prior to the sale to the ESOP. At death, under current tax law, the shareholders estate receives “stepped up” bases and the capital gains tax is extinguished. The securities portfolio may be monetized”. • Tax-Deductible Contributions • Corporate contributions used to purchase company stock or make ESOP loan principal payments are tax deductible to the corporation. ESOP Tax Shields 7
  8. 8. • Tax-Free S Corporation Income • Income attributable to stock owned by an S corporation ESOP is not subject to federal tax. This benefit may not be available for smaller companies, due to IRC 409(p). • Tax-Deductible Dividends When Paid Through the ESOP • Dividends on C corporation ESOP stock that are “passed through” the ESOP to participants or used to repay ESOP loans may be tax deductible to the corporation. These dividends are not counted in the normal contribution limit of 25% of payroll. • Allowable and Reimbursable Cost • Allowable and reimbursable ESOP contributions for Federal Government contractors. • Depending on contract type, ESOP contributions are an allowable fringe benefit cost fully reimbursable if “room in the rates” ESOP Tax Shields 8
  9. 9. Issues for Service Company ESOP Transactions Because Service Companies are “Asset Light” may need: • Pledge of personal assets • Personal guarantee • Extended Release formula • Subordinated seller financing • With warrants attached? 9
  10. 10. Warrants • Stock option cousin • Approximates private equity group mezzanine debt 12%-18% return • 10% to 15% target return • Often worth 1/3 of transaction price in approximately 5 years 10
  11. 11. Seller-Financing Structure of an ESOP Transaction ESOPSeller Company Stock ESOP Stock Note/Pledge of assets Note *Shares of stock owned by seller redeemed by Company **ESOP Shares Purchased Directly from Company in exchange for a Note 11
  12. 12. ESOP Transaction Structure with other Qualified Plan Assets SellerESOP Cash StockOther Company Retirement Plan Rollover of Plan Assets 12
  13. 13. Non-Leveraged ESOP Transaction Structure SellerESOP Stock Cash Company Cash 13
  14. 14. Contributory ESOP Structure ESOP *Stock contributed to the ESOP may be newly issued shares or shares previously purchased by Company from other shareholders Company Stock 14
  15. 15. • ESOP costs can be included as a cost of performing a government contract and reimbursed by the governmental entity • The contractor’s cost for an ESOP shall be measured by the contractor’s contribution, including interest and C corporation dividends, if applicable, to the ESOP • Contributions made in company stock shall be based on the market value of the stock at the time of contribution Additional Benefits of ESOPs for Government Contractors 15
  16. 16. Government Contractors (cont.) Challengers of Cost Reimburse Ability • Calibration of expected cost reimbursement with ESOP loan amortization • Projecting reimbursable ESOP costs, assigning them to contracts, and keeping competitive rates • It is important to communicate with the agency’s contracting officer about the ESOP 16
  17. 17. Issue for Certain ESOP-Owned Service Companies Maintaining SBA 8(a) Status • Disadvantaged owner must retain a 51% ownership interest in the company • ESOP can acquire up to a 49% in the company and future ESOP stock sales can be planned as the company graduates from the 8(a) program 17
  18. 18. History of Chemonics ESOP 1987 Our founder begins to explore the idea of an ESOP • As a way to benefit employees • To create long-term sustainability 2001 Developed the legal frame work and Summary Plan Description 2005 Board agrees to fund the ESOP 2009 Our ESOP has 10.24% ownership of the company 2011 Become 100% ESOP 2012 Funded an International ESOP 2015 Received groundbreaking IRS Private Letter Ruling for an International ESOP 18
  19. 19. International ESOP Who? 17 Countries : Afghanistan, Bangladesh, Bolivia, Bosnia & Herzegovina, Botswana, Egypt, El Salvador, Ethiopia, Haiti, Jordan, Mongolia, Nepal, Nigeria, Peru, Uganda, West Bank & Gaza, and Zambia 1,100 plus employees What? 25% of payroll which equals a contribution of ~6-8% of salary Why? One global company Sustainability of our long term local national staff Sharing in the value and growth of company Recruitment and retention of talented local staff Overall cost savings 19
  20. 20. What Does the ESOP Mean to the Company? • Cost savings through fringe & employees being fiscally smart • Staying true to the ideals of our founder • Learning to navigate our new norm of being a leveraged company • Increased staff satisfaction • Not just another government contractor in a sea of contractors 20
  21. 21. What Does the ESOP Mean to Chemonics Staff? • Security of not being bought by another company • Reaping the rewards of their hard work • Additional retirement plan • Truly living our values • Feeling part of a larger team • Increased employee satisfaction with the company over the years 21
  22. 22. What Does the ESOP Mean to Chemonics Staff? 22
  23. 23. What Does the ESOP Mean to Chemonics Staff? 23
  24. 24. Our ESOP Culture • Environment of open and honest communication and transparency • everyone has access to financials • quarterly town hall meetings with CEO and executive staff • internal portal for feedback and suggestion • annual staff feedback survey 24
  25. 25. Our ESOP Culture-Employee Outreach Committee • Educate Facilitate open lines of communication between plan trustee and employee owners • Make Aware Continuously teach the impact of being an employee owner on the company’s success • Promote Obtain feedback on ESOP and communicate to executive management team • Celebrate Recognize and celebrate the hard work of our employees 25
  26. 26. David B. Solomon Levenfeld Pearlstein, LLC 2 N. LaSalle Street, Suite 1300, Chicago, Illinois 60602 Phone: (312) 476-4526 Email: dsolomon@lplegal.com Ronald J. Gilbert ESOP Services, Inc. 251 Albevanna Lane, Scottsville, VA 24590 Phone: (434) 286-3130 Email: esop@esopservices.com Robin Jaffe Goebel Chemonics International 1717 H Street, NW Washington, DC 20006 Phone: (202) 955-3454 Email: rgoebel@chemonics.com Questions 26

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