Esop financing tool

Regardless of the form, the contributions are tax-deductible. Plan participants generally accumulate account balances and begin the vesting process after one year of full time service. Contributions, either in cash or stock, accumulate in the ESOP until an employee quits, dies, is terminated, or retires.

Distributions may be made in a lump sum or installments and may be immediate or deferred. ESOPs are of two varieties: leveraged and non-leveraged. Each of the ESOPs has different characteristics.

FunCo, Inc. These contributions are tax deductible for the company. At that time, the participant has the right to receive stock equivalent in value to his or her vested interest. Non-leveraged ESOPs, although they have certain tax advantages, generally tend to be an employee benefit, a vehicle to create new equity, or a way for management to acquire existing shares.

However, they provide a company with tax-advantages by which it can generate capital or acquire outstanding stock. A leveraged ESOP may be used to inject capital into the company through the acquisition of newly issued shares of stock. A bank or other lending institution lends money to the ESOP which acquires company stock.

The company makes annual tax deductible contributions to the ESOP, which in turn repays the loan. An ESOP can provide an employee with significant retirement assets if the employee is employed by the company for a significant period of time and the employer stock has appreciated over the years to retirement.

The diagram below illustrates the ESOP financing process:. As evidence of this improved performance, during the Great Recession of , employees of ESOPs were laid off at a rate more than four times less than employees of conventionally-owned companies.

Specifically, the General Social Survey — a joint study performed by the NCEO and Employee Ownership Foundation — showed that employee stock-owned companies laid off employees at a rate of only 2.

That, in turn, provides for shorter amortization periods and higher leverage multiples than with non-ESOP owned businesses. This improved cash-flow also allows for adequate reinvestment in the business for working capital and capital expenditure purposes, enabling the business to capitalize on growth opportunities that might not otherwise have been available through traditional third party financing arrangements.

Monroe Capital is one of a few independent middle-market finance companies that have a dedicated ESOP lending practice. In fact, according to a study conducted by the NCEO, the historical default rate for ESOPs is significantly lower than default rates on other commercial loans.

According to the study, the default rate on ESOP loans was less than one-half of one percent. As a result of this favorable default rate, lenders that have experience in this area typically will view ESOPs more favorably than other highly leveraged transactions. It is critical that borrowers looking for financing through an ESOP structure, though, work with a seasoned lender who understands the complexities of ESOP transactions.

Ultimately, the lender should be part of a team of experienced ESOP advisors that includes attorneys, valuation professionals and third-party trustees who can structure and implement the appropriate ESOP plan to meet their strategic objectives.

But when your company makes tax-deductible contributions to a leveraged ESOP to cover its loan payments, the company can effectively deduct both interest and principal.

This enhances cash flow and generates more capital. Your company can use the funds to retire existing debt, finance acquisitions or reorganizations, or provide additional working capital — or for virtually any other corporate purpose. Like other qualified plans, ESOPs come at a cost, which reduces earnings. If your company is considering an ESOP, be sure to discuss the pros and cons with your advisors.