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.