Highlights from the 2004 ESOP Conference
November 24, 2004
Eager
lenders, rising values, helpful legislation all contribute to a
compelling environment for ESOPs. Subsequently, this is a terrific
environment for business owners to consider an ESOP as a liquidity
strategy. Credit is plentiful and recent relief on S-Corp. restrictions
provides owners greater structuring flexibility.
Leveraged
ESOPs - The financing environment has improved substantially
in 2004. Across the board, senior lenders are underwriting to higher
multiples of cash flow as loan defaults decline. Traditional bank
lenders are experiencing increased competition from non-OCC regulated
entities providing cash flow loans. Lenders' appetite for large
cash flow borrowers with coverage of 1.20 is strong. Loan Pricing
Corp. reports that quarterly loan volume ended June, 2004 exceeded
$440 billion for all borrowers, up 50% over prior year.
Aggressive
second lien or "Term B" lenders have increased subordinated debt
leverage to multiples not seen over the past five years. The search
for higher yields have attracted more players into the mezzanine
market, putting competitive pressure on pricing. While previous
subordinated debt lenders underwrote to returns in the 20%+ range,
larger deals are getting priced in the teens, some with no warrant
positions.
Seller
paper continues to rise in prominence. The absence of attractive
yielding investment opportunities in the open markets has induced
selling shareholders (owners) to consider taking a larger portion
of their proceeds in paper from the sale of their own companies.
This
lending environment empowers all financial buyers, including ESOPs,
and has provided some lift to valuations.
S-Corporation
ESOPs - Congress continues to make S-Corp ESOPs more attractive
with legislation passed in October that permits dividends paid on
ESOP shares to be used to repay debt. As ESOP trusts are tax exempt
entities, the 100% ESOP owned S-Corp does not pay taxes. This effective
tax shelter allows S-Corps to accumulate a war-chest of cash, and
provides companies the flexibility to grow by acquisition or organic
growth.
Through
synthetic equity instruments, shareholders can receive appropriate
compensation for taking back subordinated seller paper as part of
their compensation. This may prove to be a sufficient incentive
to the selling shareholders to ignore the 1042 tax deferral available
for C-Corp ESOPs.
Mergers
& Acquisitions - Overall volume and value of small
M&A deals under $25 million are flat to slightly down for 2004
while transactions over $50 MM are seeing significant increases.
The private equity groups continue to drive the M&A markets,
facilitated by a more generous lending environment. However, publicly
traded strategic buyers have returned to prominence and now represent
a majority of the buyers.
The
current dynamics of the capital markets make ESOPs a particularly
attractive liquidity strategy for business owners. Fixed interest
rates remain low while lenders are offering more generous terms.
The valuations in ESOP transaction are tracking with the improved
multiples being paid in traditional M&A transaction.
PCE
Investment Bankers is a member of the PCE family of companies that
provide investment banking, valuations, advisory services, research
and Indexes.
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