Employee Stock Ownership Plans (ESOPs) 101

1. Employee Stock Ownership Plans (ESOPs) 101 Presented by: Roy Farmer

2. Full Service Business Transition Services Employee Stock Ownership Plans (ESOPs) Non-Leveraged Leveraged Corporate reorganizations Corporate refinances Company stock redemptions Leveraged mgmt/partner buyouts Third party/Private equity sales (affiliates) Business Transition Advisors, Inc.

3. Full Service ESOP Implementation Services Preliminary Analysis Feasibility Studies Plan and Transaction Design Financing Repurchase Liability Studies Employee Communications Post Transactional Services Business Transition Advisors - ESOP

4. What is an ESOP? • An ESOP stands for an Employee Stock Ownership Plan • A tax qualified defined contribution employee retirement plan • Qualifies under IRC Section 401(a) and Section 4975(e)(7) • Overseen by the IRS and the Department of Labor

5. ESOP Statistics • Modern ESOPs came into being with passage of ERISA-1974 • 10,000 ESOP companies in America today • Almost 1 Trillion in Assets Held • This includes large and small Companies • 21% of all U.S. private sector workers own company stock • Wal-Mart, Lowes, Charles Schwab, Southwest Airlines, Morgan Stanley, Motorola, Publix

6. Unique Features • Must invest primarily in employer stock • Can use borrowed funds (leverage) • No employee contributions generally allowed • Stock sold to ESOPs can qualify to defer capital gains tax – certain rules apply • Contributions can vary year to year, unless borrowed funds are used

7. Business Owner Exit Strategy/Next Generation Transfer Liquidity/Diversification for Closely Held Stock Partner Buy Out Desire for Employee Owned Culture Divorces/Immediate Cash Needs Enhanced Employee Benefits/Handcuffs Mergers & Acquisitions Uses of ESOPs

8. Plan “transition” while alive and healthy Leave with competent future leadership Minimize personal and corporate taxes Leave corporation with proper working capital and manageable, if any, debt Asset liquidity and diversification Convert business to retirement income Preserve family/community legacy Exit with the most after-tax dollars possible Owner Transition Concerns

9. The following slides show a hypothetical business worth 10-million dollars, selling 60% based on the following methods: Corporate Stock Redemption Management Leveraged Buy-Out Third Party Sale ESOP Transition Options Samples

10. Corporate Redemption

11. Management Buy-Out

12. Third Party Sale (Stock)

13. ESOP Sale: C Corp

15. How ESOP’s work

16. ESOPs can be leveraged or non-leveraged A non-leveraged ESOP allows the corporation to enjoy current corporate income tax deductions by contributing either cash or treasury stock to the ESOP Cash contributions are used to buy stock from selling shareholders At the time of the actual stock sale, the seller may still take advantage of all of the traditional ESOP advantages Non-Leveraged ESOP

17. How It Works: Step 1 The Company Adopts ESOP Trust

18. How It Works: Step 2 Company C O N T R I B UTION Stock or Cash ESOP Trust Selling Shareholders Buys Shares

19. Leveraged ESOP

20. How an ESOP Works: Step 1 The Company Adopts ESOP Trust

21. How an ESOP Works: Step 2 Lender Company Loan Loan ESOP Trust

22. How an ESOP Works: Step 3 Lender Company IRC § 1042 Loan Cash Loan ESOP Trust Selling Shareholder Stock Cash

23. How an ESOP Works: Step 4 Lender Company IRC § 1042 Loan Payment Cash Loan Cash Payment ESOP Trust Selling Shareholder Stock Cash

24. How an ESOP Works: Step 5 Lender Company IRC § 1042 Loan Payment Cash Loan Payment Cash ESOP Trust Selling Shareholder Stock Cash Employees Beneficial Ownership

25. How an ESOP Works: Step 6 Lender Company IRC § 1042 Loan Payment Cash Loan Payment Cash Cash ESOP Trust Selling Shareholder Stock Cash Interest Sinking Fund Employees Death, Disability, Retirement, Termination and Diversification

26. Selling shareholder may elect to indefinitely defer all capital gains on sale proceeds regardless of basis Similar to real estate provision IRC § 1031 and life insurance IRC § 1035 Requirements set at a relatively “low bar” Financial products specifically made to facilitate liquidity of IRC §1042 assets IRC § 1042 Tax Deferral

27. Must be a “C” Corporation ESOP must own minimum of 30% of outstanding stock post-transaction Shareholder must have owned stock for minimum of three years Shareholder must purchase Qualifying Replacement Property (QRP) within 12 months of transaction IRC § 1042 Requirements

28. Qualified Replacement Property (QRP) Note: Eligible issuer must have 50% of its assets used in the active conduct of trade or business and no more than 25% of its gross income from passive sources

29. Leveraged QRP Strategy Proceeds From Sale (1042) Portfolio Floating Rate Notes Cash Balance Income with Interest Margin Account QRP can be margined to 90% Liquid Cash

30. Leveraged QRP Strategy

31. Corporate Governance • IF YOU CONTROL THE BOARD OF DIRECTORS YOU CONTROL THE COMPANY • Corporate control • Shareholders Elect the Board of Directors • Board of Directors appoints the Officers • Officers responsible for day-to-day operations

32. In An ESOP Board of Directors appoints the ESOP Trustee The Trustee votes the stock ESOP Corporate Governance (Privately Held Company)

33. Control Can Remain “Undisturbed” Owners with stock outside the ESOP Board of Directors “Directed” Trustee Votes Appoints

34. The “Directed” trustee votes the stock on behalf of the employees The employees only have a beneficial interest in the ESOP trust Employees “advise” trustee only on Mergers, Sale, Recapitalization or Liquidation Employees are not shareholders and do not have Statutory Minority Shareholder Rights ESOP Employee Interest

35. 100% “S” Corporation ESOP • Pays no Federal or State corporate income tax to the extent ESOP owned • Taxation is “passed through” to shareholders in proportion to ownership • An ESOP is tax exempt, therefore no tax is paid on percentage owned by the ESOP • Corp does not have to distribute income • Exempt from prohibited transaction rules

36. Qualitative Benefits • “Golden Handcuffs” for key People • Reduced Turnover • Reduced Worker Comp Claims • Greater Productivity • Greater Profitability • Greater Commitment to the Company • Better Work Environment

37. Many owners wanted their family and/or key management to have business but: The owner could not afford to give the business to them Family and/or key management could not afford to buy the business As shares are repurchased and retired into treasury, the percentage of ownership of outside shares increases In theory, when the last participant share is retired into treasury, any outside shares represent 100% of the company value Legacy Full Circle

38. Legacy Full Circle: Example

39. Summary of Tax Benefits • Deferral and/or Avoidance of Capital Gains Taxes on the Sale of Stock • Deduction of the Full “Fair Market Value” of the Stock Purchased by the ESOP • Possibility of becoming “Tax Free” as a 100% “S” Corporation ESOP

40. Business owners Employees Corporations That are more advantageous than any other single vehicle WIN-Win-Win For Everyone

41. Owner wishing to cash out all or portion of business Payroll of $800,000 or greater Strong Succession Management $3,000,000 or more business value 15 + Employees or more Low cost basis ESOP Prospect Profile

42. BTA’s Role • Next Steps: • Preliminary analysis • Presentation to the client • Sufficient information to determine direction • Move to full implementation

43. BTA’s ESOP Implementation Process Team Quarterback Through Entire Process

44. Team Approach *Outside service provider

45. Roy Farmer Managing Director (208) 761-3612 rfarmer@bta.us.com Contact Information