You're a shop owner. And you're nearing an age when you'd like to get out of the business. You don't have any family members interested in taking over, so you'd like to sell it. But to whom? And for how much?

You know it may be a problem to find someone to buy it at the price you want.

Your employees also have a worry if you sell it: The new owner may not want to keep them.

So both you and your employees have concerns.

But there is a way to sell the business and at the same time benefit your employees: You can sell your shop through an Employee Stock Ownership Plan (ESOP).

ESOPs, a way to transition ownership of a company, have become increasingly popular in recent years. And the hypothetical case stated above is not the only reason an ESOP may be formed. Companies have created ESOPs as an employee retirement plan, for purposes of business continuity, financing, enhanced employee motivation, or a combination of two or more of these reasons.

According to The ESOP Association, the two most common uses of ESOPs are to buy the stock of a retiring owner in a closely held company, and as an extra employee benefit or incentive plan. These two uses probably account for more than two-thirds of all the ESOPs in existence. And the proportion of ESOPs created to buy out a retiring owner can be expected to increase, because tax provisions encourage retiring owners to sell to an ESOP.

An ESOP is an employee benefit plan that makes employees of a company owners of stock in that company.

Several features make ESOPs unique as compared to other employee benefit plans. First, only an ESOP is required by law to invest primarily in the securities of the sponsoring employer. Second, an ESOP is unique among qualified employee benefit plans in its ability to borrow money. As a result, "leveraged ESOPs" may be used as a technique of corporate finance. Some companies have used ESOPs for financing expansion, making an acquisition, spinning off a division, taking a company private, etc.

Two tax incentives make borrowing through an ESOP extremely attractive to companies that otherwise might never consider financing their employees' acquisition of stock. First, since ESOP contributions are tax deductible, a corporation that repays an ESOP loan may deduct principal as well as interest from taxes. This can cut the cost of financing to the company significantly, by reducing the number of pre-tax dollars needed to repay the principal by as much as 34 percent, depending on the company's tax bracket. Second, dividends paid on ESOP stock passed through to employees or used to re- pay the ESOP loan are tax deductible. This provision of federal tax law may increase the amount of cash available to a company compared to one using conventional financing.

A company interested in establishing an ESOP has a wide range of options in tailoring a plan that is best suited to its particular needs and goals. For example, a large, publicly traded company would handle the creation of its ESOP differently than would a smaller firm.

Once you have a general picture of the kind of ESOP you want, you need a qualified consultant to work with you to design the specifics of the plan.

If your certified public accountant (CPA) cannot provide the assistance you need, you might contact The ESOP Association, 1726 M Street, NW, Suite 501, Washington, D.C. 20036; phone (202) 293-2971; fax (202) 293-7568. This association provides a wide array of information and other assistance to companies interested in exploring the potential benefits of an ESOP. It also provides the names of consultants throughout the country.

The consultant will work with you to design the specifics of the ESOP. He or she will integrate the ESOP goals with applicable laws and regulations and will conduct a financial analysis to ensure that any financial commitments posed by the ESOP will not exceed the ability of the firm to meet such obligations. He or she may also offer possibilities previously overlooked. The consultant may also arrange to bring in other professionals, such as an appraiser or a lending institution, as appropriate.

The feasibility of an ESOP needs to be established. Answers to many questions need to be answered. Who will participate in the plan? How will stock be allocated to participants? What vesting schedule will be adopted and how will distributions of ESOP accounts be handled?

In the case of a privately held company, the feasibility and design phase of the process is not usually complete until three additional points have been addressed.

First, the firm's stock must be valued by an independent appraiser before shares are put into the ESOP.

Second, the ESOP's effect on existing stockholders should be estimated. Stockholders will want to know how the ESOP will affect the value of their stock and the company's financial condition.

Third, while not a requirement for establishing an ESOP, a plan for meeting the private, closely held company's obligations to repurchase the stock of departing employees should be projected. This repurchase obligation arises from the fact that in privately held companies, ESOP participants have a put option when leaving the company.

According to The ESOP Association, "Companies may plan for and meet their ESOP repurchase obligation in a variety of ways, including making substantial cash contributions on an annual basis, and buying insurance to cover the plan's obligations. If the likely growth of re-purchase obligation over time is projected at the outset, the company is in the best possible position to plan for it and design the ESOP accordingly."

When the process of analyzing and designing the ESOP is complete, the company will typically have an attorney prepare a formal plan document that will set forth the specific terms and features of the ESOP. An appraiser will then prepare a finished and formal evaluation report, based on data preferably no more than 60 days old at the date the ESOP is created.

The ESOP Association advises that the plan document should in- clude language addressing the plan's purpose and operation, eligibility requirements, participation requirements, company contributions, investment of plan assets, account allocation formulas, vesting and forfeitures, voting rights and fiduciary responsibilities, distribution rules and put options, employee disclosures, and provisions for plan amendments.

Other key decisions need to be made, such as who will serve as the ESOP's trustee and who will assume the functions of administering the ESOP. Increasingly, according to The ESOP Association, plan sponsors are turning to professional trustees, such as a bank or trust company, although companies sponsoring an ESOP can and do handle this role in-house.

The job of ESOP administration is likewise a function that may be given to a professional administration firm or handled by the sponsor. The administrator is responsible for maintaining all the individual records of the plan to keep track of exactly who are the current participants in the plan, the percent each participant is vested, the content and value of each participant's account, etc.

Should you decide that an ESOP would be feasible for your company, you need to explain to your employees how ESOPs work and sell them on the idea of their becoming owners of the company. All employees would be participants; you cannot just designate certain ones. Each employee would have an interest in the company.

It can be a good deal for employees. And the company will benefit, too. According to The ESOP Association, research has shown that if employees have an equity interest in the business in which they are already working, they're apt to be more loyal, more involved in making the business succeed. They will be more highly motivated. Research also has shown that companies with ESOPs have greater profits, sales and employment growth. In addition, the firms have greater ability to weather recessions than otherwise comparable companies.

Should you and your employees determine an ESOP is for you, one can be formed. When an ESOP is formed, the ESOP is the "corporation" that borrows money to pay the owner for the business. If the company is doing well and looks like it will continue to prosper, a lending institution can loan the ESOP the money to buy the business. The owner of the business would most likely get his money up front, just as does a home owner who sells his house and goes to the mortgage company to finalize the transaction with the new owner.

At its simplest, an ESOP is a trust that holds shares on behalf of employees. The bank would require that the shares be put up as collateral for the loan. Trustees of the ESOP would use future revenue of the company to gradually pay off the loan, just as a home buyer pays off a mortgage. In time, the employees would own the business.

According to The ESOP Association, a company that wants to set up an ESOP creates a trust to which it makes annual contributions. These contributions are allocated to individual employee accounts within the trust. A number of different formulas may be used for allocation, including percentage of compensation, years of service, and some combination of compensation and years of service.

Employees receive the vested portion of their accounts at either termination, disability, death or retirement. These distributions may be made in a lump sum or in installments over a period of years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP accounts.

In addition to the many financing advantages and built-in tax incentives that ESOPs enjoy, there's a great deal of flexibility in ESOPs. For example, ESOPs may buy life insurance on the owner and if the owner dies, the ESOP will be paid off.

ESOPs are not for everyone, but in the right situation, they can be a win-win deal for both employees and employer.

The process of setting up an ESOP is involved, but that should not discourage interested shop owners from investigating employee ownership. The process is understandable and manageable, and the many benefits that flow from ESOPs, such as increased employee motivation, a market for existing shareholders' shares, and tax and financial advantages, are substantial.

If you think it might be the way to go for you, start with your CPA or a good consultant. They can help you decide if it makes sense for your company. Then they can guide you toward putting the right plan for your company into effect.

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