Martin Staubus - Sometimes EXIT is spelled ESOP (D2418)

Time is precious and so are our pets, so time with our pets is extra precious. That's why we started Dutch. Dutch provides 24/7 access to licensed vets with unlimited virtual visits and follow-ups for up to 5 pets. You can message a vet at any time and schedule a video visit the same day. Our vets can even prescribe medication for many ailments, and shipping is always free. With Dutch, you'll get more time with your pets and year-round peace of mind when it comes to their vet care. Welcome to the Exit Coach radio show, the show for baby boomer business owners who are looking for cutting edge information as they plan their 3 to 10 year business succession and exit. Every week we interview top professional advisors for their best tips, strategies, and precautions so you can be well planned and don't. Miss our one minute exit coach tip of the day on exit coachradio.com. And now here's your host, the exit coach Bill Black. Welcome and thanks for listening. This segment of the show is brought to you by Olive Crest and features Martin Sabas, and Martin is with the executive director of the Beer Institute. And, uh, Martin, welcome to the show. Well, thanks, Bill, thanks for having me. It's a pleasure to have you here and we're gonna talk all about. Um, employee stock ownership plans, and there's a lot of questions that people have had about these things over the years, and the Ber Institute has become quite the expert on this particular topic, right? That's right. That's what we do. We're a center of expertise and employee stock plans. Before we dive into that, can you give our listeners a sense of your professional background? Sure, I have to confess to being trained as an attorney, um, but, uh, I I worked in the legal field for a number of years, worked at the Department of Labor, uh, becoming an ERISA expert. Uh, also had experience in the industry. I was the VP of human resources for a Silicon Valley firm for a couple of years and, uh, about the past 1215 years or so I've been doing consulting to companies on employee stock plants. So you've seen the inside of the government workings for the Department of Labor and and now you're on the the good guy side, right? Right. Spent enough time there to learn what I needed to learn and got out. Yeah. So tell us about how you got involved with the Beer Institute and, and what is the Beer Institute. Sure, the Institute, the background goes back to, uh, it was formed in 1986 by. A fellow named Bob Beyer, who was a very successful entrepreneur. He started a company called SAIC, started from scratch in La Jolla in 1969, and by 30 years later it was a Fortune 500 company, 45,000 employees globally. Uh, quite a success story. Uh, it was built on the idea that the people who worked there all had a piece of the action. They all had stock in the company. So he formed this group simply in response to all the inquiries he got from other business leaders saying they wanted to find out more about how this worked, didn't want to have to be the personal advisor of the world, created this institute, and that's what we've done ever since. So he was kind of one of the early adopters of this strategy, exactly, kind of a creator, an early adopter. And how is the Beer Institute affiliated with, uh, uh, the UC San Diego? You're right. Yeah, it was today it's part of the, uh, the business school there at UC San Diego. Uh, it was, as I say, it was. as initially as an independent group, but at the same time that Bob Beister retired from SAIC, the, uh, the campus there at UCSD was opening its new business school, the radiody School, kind of a coincidental thing. People put their heads together and say with Bob Beister retiring, he may not be there to support the group. Uh, every thought it made sense to have a part of a new business school. So since 2004. Uh, that's where we've been based, but we continue to do the same thing we've always done, which is advise business leaders in this area. Very interesting. Is there a curriculum that goes with this at the school itself, or is it? We, we do a bit of teaching. I teach a course in the MBA program, and we also have a number of what they call executive education courses. You come in for a seminar for a day or 2 or 3 that range of things, and that covers about 25% of our time and the other 75% is. Actually working hands on with businesses to help them create employee stock plans, is there a typical size of company that the strategy makes sense for? Sure. Well, in the broader sense of employee stock ownership of putting uh some stock and employee hands to motivate them, that can work from, you know, your first employee up to, you know, Fortune 500. For a specific program we're gonna talk about mostly today which is the ESOP program. It's one particular program that one is really targeted at companies that have a certain amount of size and success. They're gonna be successful private companies, so they're gonna usually be about 5 million anywhere up 100, 100 million or more in revenue. OK, so that's our, that's our audience and that's who we're targeting here. Now let's talk about from the shallow end what is an ESOP and what's its background. Right, uh, at its core, an ESOP is simply a specialized kind of, uh, an ERISA retirement plan. Uh, the only difference about it is that it's designed specifically to hold the retirement assets in the form of the company stock, uh, which doesn't sound like it's all that big a deal, but it turns out that all the features that go with this plan turn into something that's incredibly powerful and is a whole lot more than just a retirement plan. So it starts off as with the chassis of a qualified retirement plan, much like a profit sharing exit plan, right along those same lines. And so you have some qualifiers and some restrictions and that type of a thing as far as the government makes the rules, right, as far as, but the good side of that is there's, there's tremendous tax benefits as I understand. So what are some of those tax benefits exactly like all of these qualified plans, there's tax benefits and the ESOP really has them on steroids. So, uh, there are really 3 layers to this, and it's the, the first piece is driven by the fact that unlike any other kind of retirement plan, an ESOP is authorized to borrow to incur debt in order to acquire this stock that it's gonna hold for employees. So the first level of tax benefit is the fact that if an owner says, I'm gonna sell some of my stock into this retirement plan. Then basically he's going to sell his stock and if he sold it directly to the company, he would get, there's no tax deduction uh at the at the company level for spending money on redeeming stock. But if you deem it through the ESOP, suddenly it becomes tax deductible. So what would otherwise be. Spending, you know, a full dollar for every $1 of stock you sell now with the ESOP, you basically get a 40% deduction in California at state and federal taxes together. It's over 40%. Government's saying no, don't send us that tax money. Use it to to buy the stock from the owner with. So that's the first layer of benefit of the 40% savings you get at the company level. The next layer of tax benefit. Is that the selling individual, if he sold the stock to anybody else, he'd have to pay capital gains tax on it again in California you add state and federal taxes together you're looking at north of 35% of taxes with an ESOP you meet certain conditions, not too difficult, and you qualify to defer forever those taxes. So now you're another 35% layered on at the 1st 40%. Then the final piece is the employees, they get all the stock again if you didn't have the ESOP in place and you just said. I'm convinced the employee should have some stock, and I give them stock directly. That's immediately taxable income to the employees. But with an ESOP, they pay no tax by getting it through the ESOP until they eventually retire and cash it in. So they're getting another tax benefit. So you add it all up and the taxes at those three levels usually as a rough rule of thumb, they equal about 100% of what the deal is costing. So an owner who might sell $5 million of stock to the ESOP, that's going to generate $5 million in tax savings. I'm talking with, uh, Martin Saubus of Ber Institute. At the Rady School of Management. Is that right? The the radio of the School of Magic? OK, I got it right. OK. And we're gonna take a short break, Martin. When I come back, we're gonna ask you for some stories and tips and ideas and precautions for our listeners. Uh, we'll be right back after this moment. Is there a way to take money off the table on your own terms while you continue to run your company? The answer may be an ESOP, and ESOP allows you to sell any portion of your ownership to a retirement plan that will hold it for your employees. The tax advantages are large. The employee motivation is. Powerful and you gain financial security while retaining control. That's hard to beat. For more information, contact Martin Stabas at 858-822-6011. That's 858-822-6011. If you came back from lunch today and there was a resignation letter on your desk, which employee would you really, really not want it to be from? More importantly, what are you doing to prevent the situation from happening in the first place? We work with business owners like you every day to design plans that attract, motivate, retain, and reward key employees. Don't wait until it's too late. Contact Bill Black, the exit coach at 866-370-3774 for a free consultation on how to retain and reward your key employees. That's 866-370-3774. Call today. Welcome back friends. Just a reminder that we've interviewed dozens of advisors on a wide variety of topics, and you'll find all of their interviews and highlights online at exaoachradio.com or on iTunes. And I'm talking with Martin Stavas from the Viner Institute at the Raddy School of Management, and we're talking about the tremendous tax benefits of ESOPs. Before the break, we talked about the fact that the, the seller of the stock, the owner of the company, gets a tax break. Uh, a couple of times, and then the employees don't pay immediate taxes on what they end up receiving a stock until they receive the proceeds, right? Right, when they retire, and they can sell their stock and then they pay some tax at that point. Yeah. OK, so tremendous tax. Benefits and um what does this do as far as the motivational side of things? I've heard a lot of things about how this helps employees really feel like they have a stake in the outcome, which they do exactly, uh, then they do have a stake in the outcome and they have a lot more reason to pay attention. Uh, the real lesson that's been learned, there's been a lot of research done on that. This is the kind of question that interests a lot of academics, you know, business school professors, and they gather all the data from all kinds of companies with ESOPs, and they compare to companies without ESOPs, and a whole series of studies has, has, uh, confirmed the what most people would expect, which is, yeah, employees do care more about how well their company does, uh, when they actually own a piece of that company. The real critical magic in it is to explain to the employees what this is all about and how it works. We set up an ESOP, send them a memo written by your lawyer, and employees won't know what's going on. But if you take the time to educate them, teach them how the business works, show them how they can, uh, help themselves by helping the company, then you get a tremendous, uh, bang on that buck from the employees' reaction. They start getting real frugal, looking for new customers, and the companies thrive. You know, ah, can you share a couple of examples of company examples where ESO's gone in and, and that's been the case where it, it drove everything up and the values? Right, uh, one reason we had some fun with this we actually did the ESOP for, uh, the old Lawrence Welk company. A lot of the older folks remember Lawrence Welk, um, he actually put a lot of his money that he made in, in the Hollywood business into real estate and founding a company. That operates resorts and and condominium complexes around the world these days. They've got, uh, so it's a substantial company about 900 employees, um, about 100 million or so in in annual revenue. It's always been owned by Lawrence Welk's descendants. Uh, they were in a situation where, uh, one of the, the main shareholder, the, the, the leading shareholder of the family really wanted to get some liquidity. He had all the stock that. People would tell him it was worth a lot of money, but what good was it? It's just a number on paper, so they set up an ESOP. Uh, he was able to sell a chunk of his stock, uh, get a good chunk of, of cash out of that, uh, and it was all paid for really by these tax benefits. The ESOP then gets a share of the, the S corporation income distributions they made, and that enables them to pay off the debt they incurred to buy the stock with. So they're very happy with it. The employees have really responded. They're being really careful with their tools. All the gardeners are out there making sure the tools aren't left out in the rain anymore and all those kinds of things. Uh, another good example would be, uh, it's a construction company we work with out in Ontario that, uh, does commercial construction. They went through the recession very well because they didn't do housing. They did all commercial, uh, uh, schools, hospitals, those kinds of things. Uh, the owner just reached a point at his age where he thought he was pretty much getting ready to retire. So we helped him set up a retirement plan where he's got a 5 year plan, and what he's done is he sold half of his company to the employees of his ESOP, uh, last year, and the employees are all rallying around this now and helping to drive the value of the company, and he's gonna be, um, having the company pay off that that ESOP transaction over over a 5 year period and when that's done, he's gonna sell the other half and uh be able to walk away parking that money, uh, tax free. Um, so he's well into that program now, about a year and a half or so into it, and it's gone very well for him. And you mentioned a 5 year timeline, and that's what a lot of our listeners are on is kind of thinking in the next 5 years I want to be. Maybe not retired but rewired somewhat, uh, changed my life, maybe get less involved with the company, but they need that amount of time, right? It's not just to sell it and walk away kind of a thing, right? Exactly. And ESOs are very flexible and you can sell any amount of stock to an ESOP, and there are cases where an owner, uh, is really ready to go and learns about an ESOP at the last minute and then the entire company can be sold to an ESOP. But the most popular route that tends to often work the best is for the owner to sell it in 2 or even 3 bytes, and that's one of the great things about an ESOP is the fact that you can sell any portion of it and retain control because all that stock goes into this retirement plan, which is controlled by a trustee, which you as the owner appoint. So you can even serve as a trustee yourself. So no matter how much stock goes in the ESOP, the owner retains ultimate control of the company, but now he's got all the employees on his side. And it allows owners to make that kind of a gradual exit from their company where they can sell a chunk of the company. They can now begin to kind of trust the employees to kind of mind the store for them a little bit better. They don't have to work quite so hard and be there all the time to supervise. They can take some time off over the 5 year transition plan, which is, as it's not locked in stone, but it's very popular to do it that way. They're gradually turning over more responsibility to their top guys. And by the time the 5th year rolled around, they've probably already stepped down as the CEO. Maybe they're just staying on as chairman of the board, uh, and they can transition very easily, and they really appreciate the fact that their company is going to keep going rather than selling it off to some big conglomerator who's gonna buy it, fire half the guys, get rid of the name. This this baby they built is going to keep going. The right hand guys gonna have a chance to step up and and take over as the head and run it and uh. It's a great, very attractive outcome with no, no sacrifice. You get top dollar for it and, uh, everybody wins except maybe the IRS and we'll let them worry about that. Well, if somebody's exploring. This type of a situation where there's going to be a few tranches of sale, what's the minimum that they can start with if someone wants to, you know, let's try it and see what happens? What, what makes sense. Uh, there's no percentage minimum. Uh, the only factor that would bear on that is that there's out of the many benefits of the ESOP, one that I did mention was that opportunity for the selling owner to defer his own capital gains taxes, and for that particular benefit to kick in, you have to sell a minimum of 30%. OK, otherwise there's no, you can sell 5%, 50%, 12%, whatever you want to sell, and it'll all be the same, uh, except for that one. And some of these, um, tax benefits depend on the type of structure that you currently operate as, right? So most of the things you're talking about are good for a C corporation. It might be a little different for an S corporation or an LLC. or other situations, right, and if certain benefits are very attractive, you can switch. Uh, generally you never do that without the advice of your accountant, but, uh, generally speaking, companies can and do uh switch from say S to C or something if there's, they may see better advantages in the other form. Now, in your experience, um, what percentage of people that come in and talk about an ESOP pull the trigger? Uh, vast majority, once they learn about an ESOP and they understand how it works and what it does for them, uh, it's very rare anybody walks away. Usually the reaction is, this is too good, this can't be legal. And I assured them and it's been around for 35 years and thousands of companies have done it and it's completely legal, but, uh, yeah, once they really understand it, that's. So we have a couple of minutes left. Can you give our listeners some tips or precautions when when discussing or thinking about an ESOP? Uh, a couple of considerations. I one that I touched on briefly was to really maximize the benefit in terms of the company's performance. You want to make sure to really educate the employees about how the ESOP works and how the company works, so they're then empowered in the healthiest kind of way to be able to make a difference. That's one tip. Uh, in terms of cost, the costs for the ESOPs are all over the place. I always say that if you want to get an airplane ticket, you can go on Travelocity, Expedia, whatever. You can see what all the airlines are charging, and the airlines therefore have to really put its charge the going rate and can't gouge you. There's no, there's no Travelocity for ESOP advisors, so the pricing is all all over the place. You want to be careful to get the right advisors who. Um, aren't charging an arm and a leg and really know what they're doing, and if you get the right people, this becomes, um, actually one of the least expensive ways to, uh, sell your company. Great tips and a great interview. I'm sorry we got cut it a little bit short today, but how do people get in touch with you, Martin? Sure, you can reach me there at the at the UCSD Business School. Uh, my direct phone line is 858-822-6011, or simply my first initial last name. It's MStaas at UCSD.edu. Are you open to our listeners, uh. Just giving you a call and asking you questions about it. That's what we're here for. We're part of the university and we're here to, to educate, so feel free to get in touch with just with questions. OK, and is there some kind of a material on the website that they might find? Right? We have a website. We have, uh, what we call a pre-consulting form where you can give me some basic information about your company that will enable us to have a more intelligent conversation. Ah, so you can access that through our website. You can just Google Beyer Institute and find us. Beyer is B E Y S T E R. That's Institute. I've been talking with Martin Staubas, um, with Beer Institute at the Brady School of Management in San Diego, and thanks very much for coming up and taking the time today. It's been a very interesting interview. I hope our listeners will take advantage of your offer to, to get in touch, and we'll be right back after this, uh, commercial, so please stay tuned. 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