John D. Menke and Dickson C. Buxton, writing in the May 2010 Journal of Financial Service Professionals, trace the ESOP from Louis Kelso's 1956 Peninsula Newspapers buyout to about 10 million employee owners. They describe bank buyout loans near 3 times EBITDA and an ESOP sale in increments that lets the owner keep control and repay a seller note with pretax dollars, including a Section 1042 deferral for qualifying C corporation sellers.
Owners who want sale proceeds and continued control can use John D. Menke and Dickson C. Buxton's May 2010 article in the Journal of Financial Service Professionals.
Louis O. Kelso created the first ESOP in 1956 so Peninsula Newspapers, Inc. could move from two founders in their 80s to managers and employees. Its profit-sharing plan covered a 30 percent down payment. Kelso had the plan borrow the rest and repay principal and interest from tax-deductible contributions, in pretax dollars. The 1954 Code treated that loan as a prohibited transaction until Kelso secured an IRS exemption. Peninsula Newspapers prospered for 25 years before a larger firm acquired it.
Because the ESOP is a separate legal entity, a sale to the plan, including a pro-rata sale, qualified for capital gains treatment. An owner could sell in slices and repeat the sale every few years.
In 1974, Senator Russell B. Long placed the ESOP definition and exemption into ERISA. The Tax Reform Act of 1984 added Section 1042. Sellers could defer capital gains if an ESOP bought at least 30 percent of a private C corporation and they reinvested in other U.S. corporate stocks or bonds within 12 months. Reasonable dividends on ESOP shares became deductible when paid through to participants or used to repay an ESOP loan. Both rules were still in the Code in 2010.
S corporations could not sponsor ESOPs until the Small Business Job Protection Act of 1996. By May 2010, The ESOP Association had more S corporation members than C corporation members. Menke and Buxton count about 10 million employee owners, against about 8.5 million private-sector union members, and cite a 2009 University of Pennsylvania study of nearly $928 billion in ESOP assets.
For 2010 to 2015, Menke and Buxton judge competitor buyers and private equity firms short of funds, with cash-flow bank loans for buyouts near 3 times EBITDA rather than the pre-recession 5 to 5.5 times. An owner can sell to an ESOP in stages, keep control, and take a seller note. They price the uncollateralized part as mezzanine debt at 8 to 16 percent a year, or at prime plus 1 or prime plus 2 as the current rate, with the rest deferred until principal is paid. Section 1042 defers capital gains for a qualifying C corporation seller. At an S corporation, the ESOP share of earnings is tax exempt, so repayment is faster.