For construction companies structured as corporations, an Employee Stock Ownership Plan (ESOP) can be a powerful succession tool. An ESOP is a qualified retirement plan, similar in many ways to a 401(k), which invests primarily in the employer’s stock.

Tax-deductible contributions are used to buy stock (typically from exiting owners) and credited to employees’ accounts. When employees become eligible, distributions are made in stock or cash. These arrangements offer several attractive benefits:

• Owners can cash out and transfer ownership to employees gradually, without immediately giving up control.
• Owners can defer capital gains tax on their stock by reinvesting sale proceeds in “qualified replacement property,” which includes most U.S. corporate securities. (This option is available only to C corporations and only if the ESOP owns at least 30% of the company’s stock.)
• If the company borrows money to fund ESOP stock purchases, it can fully deduct contributions to cover both interest and principal on the loan.

But ESOPs have risks, as well. For example, closely held companies must conduct annual stock valuations and participants must receive a “put” option allowing them to sell stock back to the company at fair market value. It’s important to consider the potential impact of stock repurchase obligations, as well as ESOP debt, on your construction company’s cash flow and bonding capacity.