Are employees your exit strategy?

user-gravatar

Nassau Asset Management credits rising fuel costs for a nationwide increase in tractor-trailer truck repossessions and liquidations in the fourth quarter of 2005 of 145 percent compared to the same 2004 period. Edward Castagna, Nassau’s president, notes that more leased equipment was on the marketplace in 2005: “Naturally, there will be a rise in repossessions and liquidations when the pool of equipment in the marketplace has increased.”

Watkins Motor Lines says it has expanded its relationship with eCredit – a developer of online software for credit and collections professionals – to provide industry-specific data solutions to assist its credit and collections and sales departments in extending credit to its new and existing customers. Watkins, a less-than-truckload carrier, also uses an automated process from eCredit that reviews all credit lines for existing accounts at least once every 90 days.

Investment holding company Clarke Inc., based in Halifax, Nova Scotia, said its board of directors has authorized a plan to build its Clarke Road Transport unit by pursuing appropriate acquisition opportunities expected to increase its service offerings and market share. Clarke Road provides comprehensive van and flatbed services within Atlantic Canada and to all major destinations in Central Canada and the United States. Targeted acquisitions will include refrigerated operators and other businesses, the company says, and investments in the range of $5 to $50 million will be considered.

Whether you’re a Baby Boomer or part of the Greatest Generation, if you own a trucking company, one of your top concerns should be preserving what you have built. That preservation almost always starts with financial resources to live a comfortable life for decades to come. But many owners also want a legacy – a continuation of the enterprise that may have taken their entire adult lives to build. Often, that means handing down the business to a family member, but that’s not always possible or desirable. But what about your professional family – your loyal, longtime employees?

Employee stock ownership plans – commonly known simply as ESOPs – once again are gaining favor as a way to transfer companies. First created in the 1950s, ESOPs enjoyed resurgence in the ’70s and ’90s. Recently, with the lowered attractiveness of going public due to Sarbanes-Oxley and the large number of companies coming up for sale because of generational transfers and retirements, ESOPs are likely to become popular again.

Absent family succession, business owners have basically three options, says Birmingham, Ala.-based CPA Mike Brennan, who has 35 years experience in ESOPs, deferred compensation plans and supplemental executive retirement plans. “One, work until the wheels fall off and shut the company down; two, sell to outsiders; or three, sell to key employees. Of these, employee ownership often satisfies many problems and is a really attractive alternative compared to others.”

The first option clearly is unacceptable from both a financial and an emotional standpoint. The second option can be attractive financially but can be difficult emotionally because the futures of longtime employees could be on the line. The third option can be attractive both financially and emotionally. Although sales to key employees can be accomplished in various ways, “ESOPs present a unique solution and bring very powerful tax benefits to the table” for the departing owners, Brennan says.

Alternatives include employee stock options, profit sharing plans or supplemental executive retirement plans. All have attractive features and may work better for you than ESOPs, Brennan says. To find out which option is best for you, a feasibility study generally is recommended.

Whether an ESOP works for your situation depends on several key factors, Brennan says. “The key is that the company needs to be adequately capitalized – has a solid capital structure, has significant retained earnings, is operating well and has good prospects for the future.”

A stable management team also is important, he says, adding that an average tenure of key people should be 10 years or more. “And profitability is the key to the whole thing – you must have the profit and cash flow, so that adequate company contributions to the ESOP can be put in to buy out the departing owners.” Leveraged plans rarely work, Brennan says.

What really makes ESOPs work are the tax savings. “When you sell into an ESOP, you can retain, as trustee, operational control for as long as you wish – and you will have the opportunity to avoid all taxation on the transaction by investing in qualified replacement securities,” Brennan says. You then can borrow against those securities and put the money into your pocket – without yet having had to pay a dime in taxes. Most likely, you’ll invest in stable government bonds that can offset the cost of the borrowing. When you die, you get a step-up in tax basis, and taxation will be avoided – permanently.

For trucking, transportation and allied industries, Brennan highlights another bonus: “The biggest problem in trucking is driver and employee retention – turnover is usually over 100 percent per year. Why not give people a feeling that they own a piece of the rock?” Then they will be more likely to become longtime – and more productive – employee team members.

There are certainly disadvantages, and an ESOP is not for everyone. Many owners do not want the dilution of additional owners or the scrutiny it brings. Fiduciary responsibility of the trustees may put a higher standard on executive behavior, as there are new, more stringent requirements to keep all transactions between owners and the company at “arm’s length.” And under an ESOP, you must worry about stock value – and thus performance – to a degree that most privately held companies don’t.

For many, the advantages outweigh the disadvantages, but it’s not easy. In most cases, a CPA should oversee a team of the appraisal or valuation firm, plan administrator and attorney familiar with ESOPs. But the payoffs can be well worth the complexity.