A business owner looking to retire wanted to combine a tax advantaged exit strategy with the ability to retain the company’s real property as an ongoing income source. Could it be done? He brought that challenge to Acuity for an answer.
Bishamon manufactures products used in warehouse, distribution, and manufacturing environments to improve safety and enhance efficiency. The company owned its manufacturing facility.
Because the company was structured as a C corporation, accomplishing the goal of a tax advantaged sale that excluded the real property would have been nearly impossible. After our team illustrated the impact of a third party sale, either retaining the real estate or including it in a sale, the seller quickly realized that his after tax proceeds would fall well short of his expectations.
We then showed him how the possible outcomes using an ESOP were not only more favorable but would also provide his employees with the opportunity for a meaningful retirement benefit.
The Company’s valuation, including the real estate, resulted in debt service that far exceeded its cash flow using a typical amortization schedule. We also wanted the stakeholders to realize the full benefit of 100% ownership by the ESOP. That required an S corporation election at the earliest opportunity. At the same time, the real estate had appreciated significantly over the years, creating a built-in gain that precluded it from being sold for at least 5 years.
The Challenge Met
After developing the feasibility analysis, we structured the transaction. It provided significant cash at closing via a term loan with their incumbent lender, a long amortization schedule, and a seller note with interest-only payments for the duration of the term.
This gave the Company maximum flexibility in terms of a cash flow cushion, with a goal to sell the real property after the built-in gain period had expired. That would facilitate a significant paydown of the seller note in conjunction with a refinance or repayment of the senior term loan.
These design features were acceptable to the bank, trustee, and seller, were fair to the ESOP, and gave the Company the flexibility it needed to facilitate the transaction.
After a rigorous diligence process on the part of the buy-side team and senior lender, the transaction closed at a purchase price and other terms that were agreeable to both seller and buyer. Following the transaction, the seller was able to procure appropriate floating rate notes to perfect the tax deferral under Code Section 1042 and expects to hold the notes for a sufficient time period to avoid the capital gain altogether.
Careful, creative plan design, appropriate analysis of feasibility, and creative structuring of the transaction can help bring about a successful ESOP transaction despite apparent hurdles. Implementing an ESOP is a complex process best undertaken with the guidance, advice, and experience of a trusted transaction advisor.
There are many possible outcomes to a transaction. Navigating the obstacles that can impede your goals is what we do. We’ll get you the right result.