InSight

Exit and Growth Strategies for Middle Market Businesses

Divorcing – 5 Reasons For Selling Your Business to an ESOP

By Marc Borrelli | Aug 25, 2011

Divorcing – Maybe selling some of your company to an ESOP is an efficient solution.

Divorce is never pleasant, but once that decision has been made, dealing with the split of martial assets should be done in as efficient manner as possible, aside from emotion.  In most cases if one the parties (we shall call the spouse running the business “X” and the other “Y”) owns a business that was started during the marriage it is considered marital property – so in the divorce settlement it is valued and X pays Y 50% of its value and retains total control of the business.  Is this is an efficient settlement?

Many would say yes, but it can be shown that there is a more efficient financial solution in some situations.  Pass 50% of the company to Y with an agreement that Y simultaneously sells their entire interest in the company to an ESOP.  The ESOP is established with an expected life of 3-5 years at which time it will be unwound and X will buy back the 50% interest they don’t own. As said above, financially this can be better decision1  especially if capital gains taxes rise,  but in addition it has a number of other positive benefits.

•    Grow the company.  Divorce affects performance!  A headhunter once told me that they would never select anyone going through or having just gotten divorced as they are ineffective for a year.  This is true for all of us, regardless of what we think and perceive.  So during a time like this, it would be an ideal time to motivate your management team and employees to drive the company.

•    Independent Valuation.  By selling to an ESOP, an independent third party valuation is established for the company removing some of the fight between the parties.  Since the ESOP also has to get funded, it further emphasizes the value in terms of market conditions.

•    Use the Federal Government’s Fund.  The ESOP pays no income tax and so this subsidiary from the Federal Government effectively allows the ESOP to raise the money more efficiently and give a bigger bonus to your employees.

•    Capital Gains Taxes. It allows Y to pay capital gains tax on their share, rather than X paying everyone’s tax. Furthermore, if the ESOP is unwound by X buying it back, X get’s a new basis in the company which reduces X’s capital gains tax on sale.

•    Efficient use of any available liquid assets.  If X has liquid assets, X can lend them to the ESOP to fund it and earn interest, rather than just paying them to Y.

Please contact us if you wish to consider such an option for yourself or your client.

1 To view the divorcing analysis, click here.   You are welcome to change the highlighted fields on the spreadsheet so that the analysis is more meaningful to you.


One Response to “Divorcing – 5 Reasons For Selling Your Business to an ESOP”

  1. Camille says:

    It is a little misleading to say the ESOP pays no taxes and people may be confused about what is going on here. Contributions to fund an ESOP from the company (and it is almost always from the company) are tax-deductible. Employees pay no tax on the contributions until they take them out some time after termination or after they take them out of an IRA they roll them into. The ESOP is a trust and pays no taxes, much as a 401(k) plan does not, but that is not where the savings to the company come it.

    Also, if the company is an S corporation, then the percentage of ownership attributable to the ESOP is not taxable. But the tax deferral on gains from sales to an ESOP are only available to owners of C corporation stock.

    For more details on how ESOPs work, go the the Web site of the nonprofit National Center for Employee Ownership at http://www.nceo.org.

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