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Branching Out An employee stock ownership plan is more than just a great way to boost morale-it's also a cheap source of growth capital.

By Crystal Detamore-Rodman

Opinions expressed by Entrepreneur contributors are their own.

When direct marketing agency Creative Direct Response Inc. decided to expandits nonprofit fund-raising business, the Crofton, Maryland, firmbegan looking for a company to acquire. It found Jeremy Squire& Associates, an Oakton, Virginia, fund-raising company. JeremySquire, the firm's owner, wanted to sell but was concernedabout his employees. So Creative Direct Response offered a buyoutproposal that was not only financially attractive, but also a meansto reward loyal employees.

The $5.5 million firm urged Squire to sell his company stock tohis employees through an Employee Stock Ownership Plan, or ESOP.Creative Direct Response would pay Squire for the $3 million stockpurchase, acquiring the company as a wholly owned subsidiary.Because Squire provided financing, he could collect interest thatwould normally go to a bank. And since his company was a Ccorporation, he could defer capital gains taxes by using proceedsfrom the sale to buy securities of U.S. companies, a permissiblepractice when a business sells at least 30 percent of its stock toits employees.

Squire reaped big tax savings. His employees became shareholdersin the expanded operation, and the acquirer, Creative DirectResponse, was able to negotiate a lower purchase price. "If hehad sold to some third party that wasn't involved in an ESOP,he would have ended up paying between $400,000 and $600,000 incapital gains taxes," says Geoffrey Peters, 57, president ofCreative Direct Response. "By deferring those capital gainstaxes by reinvesting in U.S. securities, we were able to purchasethe company at a lower price."