ESOP Low on Cash and Options

[Guest rmwright]

The ESOP is low on cash to meet obligations where they now have substantial payouts to make to terminated and retired participants. The ESOP is obligated to repurchase the shares. The ESOP was leveraged but the loan has been paid off and the company is making small contributions. The company itself does not have substantial cash outside of the ESOP to buy the shares.

Can the ESOP distribute the stock to a participant by rolling it in kind to an IRA and then immediately re-purchasing the stock with a Note intending to buy the shares over a 5 year time frame? Would the Note be required to be secured by an entity other than the company?

Thanks for your help!

[QDROphile]

The ESOP and the sponsor should get competent professional advice about options and requirements.

Most people believe that intallment payments of the purchase price for shares under a statutory put option must be secured by tangible assets or thrid-party credit support.

[ESOP Guy]

I would add if it can be done without violating anti-cut back rules use the 5 year installment option to pay people out of the ESOP. ESOP are allowed to pay people over a 5 year period. Many document are written to allow that option to be used. You are paying people over 5 years without the loan, needing to secure the put option.

Also, is this a S corp then you have a new set of problems.

This is going to be hard to solve via a chat board.

[ESOP Guy]

You don't give much in the way of facts.

But another idea you might have looked into so this isn't much help. But just in case....

If they can get a loan they could releverage the plan. If they can't get a loan because of the money problems then the case that the loan on the put needs to be secured by something besides their good word is that more strong.

[Guest rmwright]

I would add if it can be done without violating anti-cut back rules use the 5 year installment option to pay people out of the ESOP. ESOP are allowed to pay people over a 5 year period. Many document are written to allow that option to be used. You are paying people over 5 years without the loan, needing to secure the put option.

Also, is this a S corp then you have a new set of problems.

This is going to be hard to solve via a chat board.

This is an S corp. I agree with you that this is a complicated situation. I've relied on the plan's attorney for direction and guidance but he's now come back to me for my thoughts....and the reason I'm reaching out for help!

Facts: $7M in stock and $2M in cash. $814K to distribute this year. A major stock holder is retiring this year and his account alone is almost $900K.

They are wanting to pay participants with stock accounts greater than $30,000 over a 5 year period by rolling the stock to an IRA FBO the participant and then the ESOP immediately purchasing the stock with a Note releasing 1/5 of the shares each year. Can this be done?

Thanks so much for your help!

[GMK]

So the IRA will accept a note from the ESOP. I don't see how that works (but maybe it does). Does the note require interest payments to the participant's IRA account? Personally, I would look for an alternative solution, one that puts cash into the IRA.

If the distribution is to be spread over 5 years, can you roll 20% of the stock each year and buy it back with the cash you have? At least it doesn't take out the whole $814k in one year.

ESOP's can take out a loan to acquire company stock. Can that be done in this case?

And this circumstance is not going to go away. An S corp with an ESOP needs to do some estimating of future cashouts and plan for having the money available.

[ESOP Guy]

Does anyone know if using this note in an IRA will create Unrelated Business Income Tax issues?

Here are some other ideas you might want to look into to get the owner some of his money without the IRA idea. The Put note rules seem to be such that one just doesn’t see this done much. I think you will need to find outside or asset security for the note.

Is the owner still within his diversification period? If so, have him take either the25% or 50% he can take out via that method and work on the rest when the company/plan has the cash.

Before he retires would it be possible to add an in-service withdrawal provision allowing people > x age to take 20% of their balance/ year. He would be able to get one in-service withdrawal. Down side of that idea is then other people could get a withdrawal and that might start a “run on the bank” such that the cure is worse than the problem. (Metaphor alert in that last sentence.)

If this guy is an owner he could just wait to take his distribution. After all he knew his retirement plans and could have influenced how the company spent its money so that it was more prepared for this. I realized some of this could be the economy. I have several ESOP clients suffering currently. But we do regular liquidity studies for them so large distributions don’t sneak up on them. Those studies include asking large balance holders what their plans are. I suppose plans could also change, ie he got sick suddenly and that forced his plans to change. Obviously, don’t know the details, but if he was a major stockholder he had some say on how this situation happened.

But waiting would allow the company or plan to accumulate the needed cash.

Lastly, the final solution to any ESOP’s cash flow problems is sell the company. I have seen more than one company be forced to sell itself because of this problem.

[Guest rmwright]

So the IRA will accept a note from the ESOP. I don't see how that works (but maybe it does). Does the note require interest payments to the participant's IRA account? Personally, I would look for an alternative solution, one that puts cash into the IRA.

If the distribution is to be spread over 5 years, can you roll 20% of the stock each year and buy it back with the cash you have? At least it doesn't take out the whole $814k in one year.

ESOP's can take out a loan to acquire company stock. Can that be done in this case?

And this circumstance is not going to go away. An S corp with an ESOP needs to do some estimating of future cashouts and plan for having the money available.

Yes, the note will require an annual interest payment of 2.5%.

They are wanting to transfer the entire number of shares of stock to the IRA and then the note to lock in the value of the stock at the time of distribution.

They may can take out a loan but I'm sure they don't want to at this point.

The cash flow situation has occurred because of the economy - a company directly related to the construction industry.

[Guest rmwright]

Does anyone know if using this note in an IRA will create Unrelated Business Income Tax issues?

Here are some other ideas you might want to look into to get the owner some of his money without the IRA idea. The Put note rules seem to be such that one just doesn’t see this done much. I think you will need to find outside or asset security for the note.

Is the owner still within his diversification period? If so, have him take either the25% or 50% he can take out via that method and work on the rest when the company/plan has the cash.

Before he retires would it be possible to add an in-service withdrawal provision allowing people > x age to take 20% of their balance/ year. He would be able to get one in-service withdrawal. Down side of that idea is then other people could get a withdrawal and that might start a “run on the bank” such that the cure is worse than the problem. (Metaphor alert in that last sentence.)

If this guy is an owner he could just wait to take his distribution. After all he knew his retirement plans and could have influenced how the company spent its money so that it was more prepared for this. I realized some of this could be the economy. I have several ESOP clients suffering currently. But we do regular liquidity studies for them so large distributions don’t sneak up on them. Those studies include asking large balance holders what their plans are. I suppose plans could also change, ie he got sick suddenly and that forced his plans to change. Obviously, don’t know the details, but if he was a major stockholder he had some say on how this situation happened.

But waiting would allow the company or plan to accumulate the needed cash.

Lastly, the final solution to any ESOP’s cash flow problems is sell the company. I have seen more than one company be forced to sell itself because of this problem.

No, he's already diversified and beyond that time frame.

We have been monitoring the liquidity issues in the plan but the downturn in the economy greatly affected the company and has caused "early" retirement for several of the larger stockholders as well as a lower contributions.

[GMK]

They are wanting to pay participants with stock accounts greater than $30,000 over a 5 year period by rolling the stock to an IRA FBO the participant and then the ESOP immediately purchasing the stock with a Note releasing 1/5 of the shares each year.

I'm missing something here and don't think I'm much help.

I don't quite get this idea of saying that you're paying participants over a 5 year period but rolling all the stock into the IRA at once. I understand that this locks in the stock price and the 2.5% interest rate, but I don't understand what happens to the stock secured by the ESOP's note. Is it like in a suspense account in the ESOP with 1/5 of the shares released each year and allocated to then current participants? And as others asked before, what guaranty is there for the note? Who pays the interest?

And I don't see how the 100% rollover with a note is better than 20% rollovers each year. OK, you want to lock in a stock price (and interest rate) in case the stock value goes up a lot over the next 5 years. But if business gets good (and we all hope it does), then there'll be money to do the buy-backs of the 20% per year rollovers without a Note. If business gets really good, you don't have to wait 5 years to finish the distribution. If business lags, the stock price will likely drop some, saving the company on the distributions in later years (which the participant would like to avoid, and may foresee).

There are probably other factors that I don't know to mention, and I wish I could be of more help. I think it's back to the ERISA lawyer for an opinion.