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Kelly O. Finnell, J.D., CLU, AIF® President, Executive Financial Services, Inc. ESOPs and Estate Planning

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Page 1: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Kelly O. Finnell, J.D., CLU, AIF® President, Executive Financial Services, Inc.

ESOPs and Estate Planning

Page 2: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Next Big Estate Planning Opportunity

2

Baby Boomer Business Owners

72% Planning for Monetization Event

62% Planning in the next 5-6 Years

Source: PricewaterhouseCoopers, Trendsetter Barometer™

Page 3: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Next Big Estate Planning Opportunity

3

Baby Boomer Business Owners

Source: White Horse Advisors, Survey of Closely-Held Business Owners

Page 4: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Monetization Planning Strategies

4

Lifetime Gift to Family Member

Sale to Third Party

Private Equity Group

Strategic Buyer

Management Buy-Out

Traditional Exit

Paths

Page 5: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Monetization Planning Strategies

5

Lifetime Gift to Family Member

Sale to Third Party

Private Equity Group

Strategic Buyer

Management Buy-Out

Traditional Exit

Paths

Employee Stock Ownership Plan (ESOP)

Page 6: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Did You Know . . .

Companies Can

Owners Can

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Deduct Loan Principal

Deduct Dividends Paid

Operate as Tax-Exempt Entity

Control Company After Sale

Sell Company Tax-Free

Page 7: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Did You Know . . .

7

ESOPs Create Estate Planning Opportunities

Post-Transaction Drop-In-Value

Minority Interest Discount

Page 8: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Agenda

Overview

Tax Advantages

Key Issues

Estate Planning

8

ESOP Candidates

Page 9: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Overview

What is an ESOP?

How Does an ESOP Work?

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Page 10: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

What is an ESOP?

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Page 11: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

What is an ESOP?

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Qualified Retirement Plan

2½ times Greater Contribution

Page 12: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

What is an ESOP?

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Tax Efficient Liquidity

Keep Control

Ensure Legacy

Page 13: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

What is an ESOP?

13

Pre-Tax LBO

Tax-Exempt Corporation

Page 14: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 15: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

How Does an ESOP Work?

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Stock

Cash & Seller Note(s)

Selling Shareholder(s)

Outside Loan Company

ESOP & ESOP Trust

Inside Loan

Page 16: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Tax Advantages

Corporate Pre-Tax Debt Payment

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Tax-Free Stock Sale

Tax-Exempt Corporation

Page 17: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Tax Benefits

17

$10M Sale of Stock

MBO Or

Redemption ESOP

ESOP Tax Savings

Proceeds to

Shareholders $7.62M(1) $10.0M $2.38M

Cost to Company $10.0M $6.6M(2) $3.4M

$5.78M

(57.8%)

(1)Assumes 23.8% federal tax on sales proceeds

(2)Assumes 34% federal corporate tax rate

Page 18: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Tax Benefits

18

Assuming C-Corp Asset Sale Taxed at 35%

ESOP Sale $10,000,000

Taxable Sale $15,384,615

Net to Seller $10,000,000

Capital Gains Taxed at 23.8%

ESOP Sale $10,000,000

Taxable Sale $13,123,359

Net to Seller $10,000,000

Page 19: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Tax Benefits

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Tax-Affected AEBITDA Multiples

Tax Rate

0.0% 23.8% 35.0%

Mu

ltip

le

4.0 4.0 5.25 6.15

4.5 4.5 5.91 6.92

5.0 5.0 6.56 7.69

5.5 5.5 7.22 8.46

6.0 6.0 7.87 9.23

6.5 6.5 8.53 10.00

7.0 7.0 9.19 10.77

Page 20: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Tax Benefits

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NO TAX ON

CORPORATE

INCOME!

100% ESOP Owned S-Corporation

Page 21: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Tax Benefits

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$10M Sale of Stock

MBO Or

Redemption ESOP

ESOP Tax Savings

Tax on

Company’s

Income $792,000(1) $0M(2) $7.92M(3)

(1) Assumes corporate earnings of $2M per year and 39.6% tax rate

(2) Assumes 100% ESOP-owned S Corporation

(3) Assumes $792,000 per year for 10 years

Page 22: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 23: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 24: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Key Issues in ESOP Planning

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Valuation

Financing

Control

Page 25: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 26: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Valuation

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Industry

Revenue

AEBITDA

100% Valuation

Multiple

Tax Status

Defense Contractor

$266M

$25.18M

$180M

7.15x

C-Corp

Manufacturing

$10M

$.923M

$6M

6.5x

C-Corp

3rd Party Logistics

$213M

$5.00M

$45.34M

9.61x – $4M debt

C-Corp

Page 27: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Financing

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Excess Company

Cash

Seller Notes

Bank Loan

+ + Total

Transaction =

Page 28: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Financing

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$2M $4M $4M $10M + + =

$6M Cash at Closing

$320,000/year (8% Interest + Warrants)

Excess Company

Cash

Seller Notes

Bank Loan

+ + Total

Transaction =

Page 29: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Financing

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Sources of Cash for Repayment

Tax Savings

401(k) Match

Owner’s Adjusted Salary/Bonuses/Perqs

Corporate Earnings

Page 30: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 31: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 32: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Control

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Page 33: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

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Page 34: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Estate Planning Opportunities

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Estate, Gift, and Charitable Planning

with ESOPs

Page 35: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Estate and Gift Planning

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Key Concepts

Post-Transaction Drop-in-Value

Minority Interest Discount

Page 36: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Post-Transaction Drop-In-Value

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Pre-ESOP Post-ESOP

$10,000,000 Enterprise Value

$1,000,000 Excess Cash

($1,000,000) Debt

$10,000,000 Equity Value

$10.00 Price Per Share

Page 37: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Post-Transaction Drop-In-Value

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Pre-ESOP Post-ESOP

$10,000,000 Enterprise Value $10,000,000

$1,000,000 Excess Cash $1,000,000

($1,000,000) Debt ($6,100,000)

$10,000,000 Equity Value $4,900,000

$10.00 Price Per Share --

Minority Interest Discount ($1,225,000)

NPV of ESOP Tax Benefits $1,354,000

Post-Transaction Price Per Share $5.03

Page 38: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Estate and Gift Planning

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100% ESOP Transaction

Lifetime Gift of Warrants

Page 39: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Estate and Gift Planning

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Gift of Remaining Shares

Post-Transaction Drop-in-Value

Minority Interest Discount

51% ESOP Transaction

Page 40: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Estate and Gift Planning

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Gift of Remaining Shares

Post-Transaction Drop-in-Value

Minority ESOP Transaction

Page 41: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Charitable Planning

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Gift of Company stock to Charity or CRT

Income Tax Deduction

Charity or CRT sells stock to ESOP

ESOP owns stock

No Recognition of Capital Gain

Owner has income stream from CRT

Use CRT as § 1042 alternative

Page 42: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

Charitable Planning

42

Owner sells C-Corp. stock to ESOP

Elects § 1042 deferral

Owner makes gift of QRP to CRUT

Income Tax Deduction

No MID

Owner receives income for life

Page 43: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Candidates

43

Business Owner Characteristics

Tax Motivated

Legacy Motivated

Control Motivated

Employee Motivated

Tried Sale and . . .

Page 44: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Candidates

44

Company Characteristics

Tax Motivated

Equity Incentives

Strong Successor Management

Cash Flow (EBOC or AEBITDA) ≤ $1MM

Payroll (excluding Owner) ≤ $1MM

Page 45: ESOPs and Estate Planning - StarChapter...ESOPs and Estate Planning Next Big Estate Planning Opportunity 2 Baby Boomer Business Owners 72% Planning for Monetization Event 62% Planning

ESOP Estate Planning Opportunities

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Questions?