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Employee-owned companies and equipment

Some factors to consider

Douglas Dell //May 13, 2015//

Employee-owned companies and equipment

Some factors to consider

Douglas Dell //May 13, 2015//

As a growing number of business owners approach retirement age, more and more are considering Employee Stock Ownership Plans (ESOPs) as they put their succession plans in place. ESOPs, which provide a company’s workforce with an ownership interest, are certainly not new. In fact, according to the ESOP Association, there are approximately 10,000 ESOPs in place in the U.S., covering 10.3 million employees (10 percent of the private sector workforce), with asset values approaching $1 trillion. ESOPs represent a wide range of enterprises, with manufacturing, construction and engineering foremost among them.

ESOPs provide a great way for business owners at closely held companies to transition into retirement while also protecting their legacy and providing a long-term incentive for employees.  In addition, there are significant tax advantages afforded the ESOP structure that provides the ESOP company additional cash flow to finance the purchase of its stock. In fact, a 100 percent ESOP owned S-Corporation is essentially a tax-free entity.       

For an existing ESOP company that enjoys those tax benefits, the decision on how to finance on-going capital expenditures, including equipment purchases, should be considered carefully. There is rarely a single, best answer to the question of how to pay for required equipment; equipment financing programs vary, but a customized structure can help ESOP companies reach their financial objectives, optimizing both cash flow and tax savings.

Here are some factors ESOPs should consider when it comes to acquiring capital equipment:

Cash purchase?

For big-ticket equipment acquisitions, the downsides of a cash purchase or borrowing to buy equipment can outweigh the benefits of ownership. Although a traditional loan – which works like cash – can even out cash flow, it also results in outright ownership, which is not necessarily a good thing. For example, technology that is frequently updated or improved also becomes quickly outdated. In that event, buying replacement equipment becomes the only recourse, and a costly one, at that. Further, the tax advantages of equipment ownership are often diluted for ESOPs.  After all, the value of equipment comes from using that equipment, not from owning it.

Equipment depreciation impact

Because an ESOP-owned company may have limited or no tax liability, the benefits from MACRS – or accelerated equipment depreciation – may be limited. This is especially true for S-Corp ESOPs, which according to the NCEO comprise 40-45 percent of all ESOPs.

In contrast, most public companies that are full taxpayers may take full advantage of depreciation to lower the corporate tax burden and improve their bottom line.

ESOP tax leases

To optimize tax benefits, ESOPs increasingly turn to equipment leasing as an alternative financial planning strategy. In fact, some leases offer benefits that are especially well suited to ESOPs.

For example, a tax lease shifts tax ownership from the user to a qualified lessor. The lessor can then use the tax benefits of equipment ownership efficiently, allowing them to offer lower lease payments. The ESOP effectively trades its unusable tax depreciation for those lower payments from the lessor.

In addition, leasing gives an ESOP the option to purchase equipment at the end of the lease or return the equipment if it no longer fits the company’s business needs.

Leases suit a huge range of equipment, technologies and services

As noted earlier, ESOPs comprise a wide variety of businesses. Whatever an ESOP’s demands for equipment acquisition, the chances are excellent that a lease can fulfill them. An ESOP can use leasing to acquire a remarkably broad range of equipment, as well as provide options for upgrades, training and installation, and to mitigate against equipment obsolescence, as well.

Consider, for example, some of the ESOP-related industries and equipment serviced by leasing today:

  • Manufacturing
  • Agriculture
  • Food processing
  • Vehicles
  • Healthcare
  • Machinery
  • Printing
  • Transportation
  • Mining 
  • Construction

Within an ESOP, equipment financing can be used as a strategic tool. It lets a company acquire and deploy revenue-generating assets immediately and develop a plan to achieve long-term goals.

Assembling the team

By their very nature, ESOPs have unique and specific tax requirements. To develop the most profitable equipment acquisition strategy, be sure to consult with an equipment financing expert. Look for someone who has a background in tax lease structuring and ESOP industry expertise – as well as an understanding of your unique business goals.

A qualified lessor who understands ESOPs can work with company management and their financial advisors to assess current and future asset needs. The lessor can also perform a lease vs. buy analysis, which helps determine whether a lease or loan is the best alternative, given the company’s specific financial situation.