The current merger and acquisition market is one of the strongest we’ve seen in years. If your company has made it through the pandemic in a strong position, it could be highly valued in an acquisition. With the high multiples for companies in the current market, you need to consider what your best option might be: sell now or continue to grow and evaluate your options at a later date. For ESOPs, this choice can be difficult. Fortunately, there is a way to evaluate your alternative without testing the market.
Engage with an investment banker to provide a sell-or-hold analysis. This independent evaluation of your company will help you determine what your value is, based on current market factors as well as an analysis of the field of potential buyers and what the interest level might be. This tool will help the company’s board and ESOP trustee determine the best path forward.
The ESOP Dilemma
ESOP trusts provide companies with an evergreen ownership option that solves one of the biggest issues facing privately held companies: ownership succession. Who owns the company now and in the future? ESOPs know the answer. It’s the ESOP and the employee-owner participants of the ESOP. And not just the current employees but also the future employees who will help drive growth and ultimately value. The ESOP infrastructure allows for ongoing liquidity, funded through tax advantages, which means ESOP-owned companies never have to sell to provide return to their owners. They can go along as an ESOP-owned company forever. But how does the board maintain its fiduciary responsibility in deciding whether to buy (invest more into the growth of the company), sell the company, or hold (maintain the status quo). At the end of the day, the board is required to do what is in the best interests of the ESOP participants.
The number of ESOP-owned companies has remained fairly steady over the past decade, at around 6,700, according to data compiled by the National Center for Employee Ownership. This consistent figure reflects the significant number of new ESOPs being created while a similar number merge, become acquired or go out of business altogether. Some of these ESOP terminations are a result of market forces and business failures. Like all businesses, ESOPs are not immune to general economic conditions or management ineptitude. But many of these exits are the result of proactive ownership designed to maximize shareholder return for the benefit of the ESOP participants. You need to know if you should be in this latter category.
The ESOP design allows ESOP participants to realize their investment in retirement, through share repurchase. Share repurchase is based on the ESOP’s annual valuation, but that may understate the true market value of the shares. It might be a significant understatement compared to what a third-party buyer may pay for the company in a sale. While neither the board nor the trustee has a legal obligation to investigate all possibilities, many will at least make the effort to evaluate opportunities on the chance that a sale could benefit the company and the ESOP participants.
You may have received multiple inquiries regarding selling the company – especially in the current strong market. Wading through the real offers is time-consuming, and the fishing expeditions some pseudo buyers embark on are downright annoying. The responsibility for analyzing your options in these situations may come in the form of formally reviewing market conditions, offers and opportunities at the board or committee level every two or three years. What you really need is a rather sophisticated, timely sell-or-hold analysis that ensures the company is moving in the right direction for the benefit of the ESOP participants.
What’s a Sell-or-Hold Analysis?
A sell-or-hold analysis is a valuable tool that will tell you if you should devote time and expense in evaluating a third-party sale. It’s what the informed ESOP trustee relies on to determine the best course for the company. The ESOP trustee has a different standard to uphold compared to other privately held companies, since the trustee acts as the ESOP participants’ fiduciary and therefore must act to ensure their benefit. But it is not easy for most trustees to gather the information necessary for a sell-or-hold analysis. That’s where a professional comes in, someone with access to all the data needed to make a full study resulting in a comprehensive sell-or-hold analysis. A professional advisor will gather at least the following:
- Broad industry overview
- A detailed company analysis
- Accurate, reviewed evaluation
- A list of all potential buyers
- Complete comparison of a third-party sale versus an ESOP
With this data in hand, the professional advisor will help you compare what a third-party might pay for your company versus the current ESOP valuation. Barring a meaningful difference in total value to the shareholders, it is probably not worth the effort to go through a sale process unless there are extenuating circumstances, such as a large unfunded repurchase obligation. If the value and market conditions prove to be advantageous, where a premium to the current valuation can be achieved, you might have the proof necessary to go to market. This is the essence of a sell-or-hold analysis, a tool that can provide the necessary guidance to make critical decisions about the company’s future and achieve the best result for the participants.
If you have questions about a sell-or-hold analysis and whether one can help you, please contact PCE. We’ve helped a number of ESOPs through this process.