Advice You - Business

In view of the complexities of the financial accounting and federal tax rules governing ESOPs, many ESOP sponsoring companies lose sight of larger issues and become buried in the technical details of their ESOP and remain fixed on a single use for their ES

According to USFDA, a combination product is one composed of any combination of a drug and device; biological product and device; drug and biological product

OP. Short term benefits of a particular ESOP strategy should not overshadow longer term objectives of the company and alternative uses for their ESOP should be addressed every couple of years.

Typical ESOP Transaction

A very typical scen

; or drug, device, and biological product and fixed dose combination would include two or more combinations of drug.

Examples of combination products may in

rio in the life cycle of ESOPs is the case where the plan was originally adopted to provide a tax-favored means of buying out the equity of one or more major shareholders in a privately held corporation. This objective can be accomplished using borrowed f

lude drug-coated devices, drugs packaged with delivery devices in medical kits, and drugs and devices packaged separately but intended to be used together.

nds from a bank lender or funds provided by the corporation in the form of a loan to the ESOP trust. Whatever the method, over time the buyout is completed, successor management is firmly in place, and the equity that was formerly owned by the selling sha

here is enormous increase in the number of combination products entering the market in the recent years. Combination products have proven advantages but fixe

eholders becomes equity owned beneficially by the plan’s employee participants.

The Repurchase Liability

Up to this point, the corporation has enjoyed the advantage of deducting the yearly contributions made to the plan to service the loa

d dose combinations are still in the process of convincing regulatory authority on their advantages over the single ingredient formulations.

Combination pro

to accomplish a well defined purpose. For the publicly traded company, there is little downside in such a case since the shares that are distributed to retiring and terminating employees can be sold on the open market. The corporation, in this case, is

ucts have become life saving products for the pharmaceutical companies who doesn’t have many innovative molecules in their product pipeline and have been inc

burdened only with the administrative costs of operation of the plan. For the privately held corporation, however, the benefits of the original objective could all be lost if another strategy is not implemented.

Federal tax rules require that employee pa

easingly used in the product life cycle management. Even the companies having product patents are trying to extend their product life cycle through the combi

ticipants must be granted a “put option” wherein the company or ESOP is obligated to buy back the shares from separated participants at the then current fair market value. Without this provision, the prospect of owning shares in a private corporation with

nation products and maximize the revenues. But the companies involved in this practice are overlooking that they are burdening the patients both economically

little or no market would be of nominal interest to most employees under most circumstances. This obligation to fund the conversion of ESOP shares into cash is referred to as the “repurchase liability.” Once this liability is recognized, the company need

and physically. They need to rightly judge the benefits of the combination products and they have to even look at the risks involved when combining the produ

to decide whether or not to have the ESOP or the company repurchase the shares. There are pros and cons to both and this will depend on the long term strategy of the company and the ESOP.

Redemption or Repurchase?

Shares can be repurch

ts. Some of the combination products were well accepted by physicians while others suffered. Companies involved in development of combination products are fi

sed by the ESOP using cash that was contributed to the ESOP on a pre-tax, making this the preferred approach. Another alternative is to adopt a policy of purchasing shares from separated participants by the company. This is, of course, an outlay of cash

ding difficulty in defining their combination products and facing various challenges from selecting a combination to marketing it.

Following aspects would a

for which no federal tax deduction is available. When the trust uses deductible cash contributions to buy back shares from separated participants, these repurchased shares are reallocated to the remaining participants and the process continues as the same

dd to the challenges in developing combination products:

Which markets to tap where the combination products can do fairly well?
Which combination prod

shares are purchased over and over again by the trust.

Buy back of shares by the company, however, leads to a reduction or possible total elimination of this liability. If this alternative appears to be the most feasible, other forms of incentive compen

cts are meaningful and rational?
Which therapeutic categories to select?
Which Combinations can address unmet needs of the patients?
Do combin

ation or retirement oriented benefit programs should be considered as part of the transition. In other words, an overall strategy should be implemented but addressed again as the ESOP mature and the objectives for the ESOP change.

ESOP as a Profi

tions increase the patient compliance?
What would be the developing cost?
How to tackle the risks encountered during combination product developmen

Sharing Plan

Continued federal tax deductible cash contributions can be made to the ESOP and invested in other securities or used to buy additional employer company shares, either newly issued or from non ESOP shareholders. Launching into a new

t?

As combination products don't fit into the traditional categories of drugs, medical devices, or biological products, the USFDA is in the process of devel

round of borrowing is not necessary if there is adequate cash in the plan. Cash funding the ESOP will also mitigate the impact of the repurchase liability.

Increasing Cash Flow

The company can merely contribute newly issued shares for whi

ping new procedures for reviewing their safety, efficacy and quality.

Professional from academic institutions, pharmaceutical industries, health care indust

h a federal tax deduction is available. Remaining plan participants receive additional shares in their accounts from the forfeiture of unvested shares of separated employees. If the share values increase over time, this is another means of realizing app

y and representatives from various regulatory agencies are working out to design the regulatory requirements for manufacture and sale of combination products

eciation in the individual ESOP accounts; however, increasing share values mean increasing repurchase liabilities.

Importance of a Strategy

Unless the ESOP is used by successor management to achieve new objectives such as funding acquisit

.

As there is an increasing trend of the combination products companies manufacturing such products should be able to tackle the problems involved in the de

ons with tax deductible dollars or other strategies that offset the negative aspects of the drain on corporate cash flow to fund ever growing repurchase liability, the long term advantages of winding down the ESOP’s share holdings should trump the short te

elopment. They need to be wiser in analyzing the market trends and the regulatory requirements.

Companies that provide selfless information through particip

m advantage of the deductibility of yearly cash contributions to fund repurchases. Recognition of the need to formulate changing strategies for changing circumstances should be made when the plan is initially adopted and ever few years as the ESOP matures

tion in industry events and feedback to regulatory authorities would be able to face the challenges and will be successful in developing combination products

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