The sweeping changes that Congress has made in the laws regarding employee stock ownership plans (ESOPs) could lead to some fierce battles in the acquisitions market.
ESOPs enable employees to acquire company stock through tax-deductible contributions by their employers. The tax package encourages the creation of ESOPs -- of which there are now about 6,000 -- in a number of ways, including inducements for banks to lend to ESOPs and tax breaks for owners who pass dividends through them (see Financial Tactics, page 171).
But perhaps the law's most important feature is that it removes the tax advantage of selling out to another company. Previously, business owners who sold their companies for an exchange of stock got preferential tax treatment. The new law grants the same treatment to owners who sell their stock to an ESOP and reinvest the gains within a year.
As a result, owners cashing out of their companies could find themselves in a tug-of-war between their ESOPs and competing bidders. "There is going to be cutthroat competition between the employee groups and the larger companies," predicts Joseph Blasi, a lecturer in social studies at Harvard University. "Each will try to prove to the owner that its offer is better."
Owners, meanwhile, may choose to make the most of the situation by raising their asking price. "I think it will increase the amount the owners can ask," says Barbara Ridout, executive director of The ESOP Association in Washington, D.C. "Although I would think the owners would have a loyalty toward their employees it's still a business deal."
But because of another provision in the tax law, an ESOP offer may be more than it appears to be. The regulation -- allowing banks and other commercial lenders to exclude from their taxable income half of the interest they earn on loans to ESOPs -- could make ESOP loans more attractive to bankers.
As a result of the two provisions, "an employer can essentially take a smaller offer and still come out ahead," Blasi says. Not only does the employer benefit from the initial tax savings, but he can be assured that the employees will be able to secure loans to keep the company in sound financial health.