ESOP VS CRT: Which path is right for you?

By STS Capital October 24th, 2022

In order to shelter and protect yourself from taxes in the United States, it’s essential to consider the aspects of your future sale that will need to be managed. There are two types of programs to consider when planning to sell your business along with tax planning that will need to occur to set you up for a successful exit. The two programs available are ESOP (Employee Stock Option Plan) and CRT (Charitable Remainder Trust). Continue reading to dive into the specifics of these programs, the advantages, and disadvantages, and how you can best set yourself up for an Extraordinary Exit.

An ESOP is a tax-advantaged transaction alternative to a third-party M&A sale. The ESOP provides a company’s workforce with an indirect ownership interest in the company (the “plan sponsor”) at no cost to the employee. To realize liquidity and transition ownership, shareholders of the company have the flexibility to sell the entire business or a minority percentage interest in the business to an ESOP.

In an ESOP purchase, ownership transfers through creating an Employee Stock Ownership Trust (ESOT) that may ultimately purchase the company at fair market value. In a typical ESOP transaction, the company borrows money from the bank, selling shareholders or a combination of the two. The company then loans that money to the ESOT, and the ESOT then gives the money to the seller in exchange for the stock.

The costs associated with ESOPs are high, both initially and annually. The company must be financially capable of repurchasing stock from employees as they leave. As such, the repurchase liability stays with the company, and there is an obligation to buy back shares from employees. ESOPs are subject to federal ERISA regulations and can be challenging to structure without the guidance of advisors that specialize in ESOPs.

A charitable remainder trust (CRT) is a “split-interest” giving vehicle that enables business owners to pursue tax minimization and financial goals while still generating income. The company can contribute assets to the CRT and retain the right to receive trust distributions based on either annuity or annual valuations. The charity gets the “remainder,” i.e., assets after the expiration of the “term” held by the family. Through careful choice of jurisdiction, planning, and drafting, taxpayers may enhance the after-tax benefits of a CRT – so much so that the after-tax benefits substantially outweigh the charitable cost.
With a CRT, the remainder of the interest goes to the charity, not the company, and is irrevocable once finalized. You must also consider that certain investments, such as direct ownership in operating businesses structured as LLCs or debt, are prohibited.

One of the challenges you may face with an ESOP is that most owners that exit want to retire and begin their next endeavor, but with an ESOP, they won’t receive such freedom. Whereas with a CRT, the business is sold to a third-party providing ease of liability and simplification in the process.

Headshot Troy Wright SecondaryTroy Wright, Managing Director at STS, has worked closely with entrepreneurs looking to achieve an Extraordinary Exit and maximize their legacy potential. Alongside strategic execution, he believes that utilizing CRT in your sale provides an opportunity to create a lasting impact on your business and your community. The portion of the final amount of your sale is a structure donated to a non-profit or charitable organization of your choice. We can establish your Success to Significance and place those in the final stages of your CRT. The CRT contribution typically amounts to 10% of the starting amount of the trust, which ends up being as low as 3 to 4 percent based on the returns earned.

As entrepreneurial business owners, we know selling a business is never just a transaction; it’s a journey. We are the expert guides to see you through to maximizing multiple financial values and facilitating legacy potential. STS believes that it’s imperative that business owners who are contemplating selling their company consider their tax planning ahead of any sale so that the tax planning vehicles and preparation can be done before getting into the sales approach. This planning becomes a critical success factor in achieving your Extraordinary Exit.

*Please note that programs and incentives available upon the sale of a business vary by country. The information and guidance provided in this blog post on ESOPs and CRTs are specific to businesses registered in the United States.

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