Daily, the sale or merger of a company involved in a service industry grabs the headlines. Whether a service provider to the healthcare, insurance or other industry, it feels like all companies and industries are in “play”. The announcements of these sales or mergers are normally accompanied with assurances from management that the ownership change will not adversely affect employees or the level of service to customers.
An Employee Stock Ownership Plan (ESOP) is a company sponsored, employee benefit plan that is analogous to a profit sharing plan. For privately held business owners, ESOPs can be a liquidity strategy that offers numerous benefits to the owner, business and its employees. These plans are usually leveraged (using debt to acquire the stock), and the capital borrowed can be different than debt incurred in normal course of business.
Implementing an Employee Stock Ownership Plan (ESOP) as part of a diversification or exit strategy for business owners fell out of favor in recent years as the credit crisis reduced liquidity options. All evidence, including recent transaction activity, indicates liquidity has returned to the ESOP market. This development, coupled with several research studies completed by various academic and non-profit research institutes, makes the sale to an ESOP a compelling strategy for today’s business owners who want to participate in the future growth of their business while diversifying personal assets.
While recently attending the Employee-Owned S Corporation of America (ESCA) Federal Policy Conference in Washington DC, I was struck by the fact that both Democrat and Republican congressional leaders who spoke at the conference were in support of current legislation that expands the idea of broad based employee ownership in privately held companies.
In an active M&A market, business owners are using Employee Stock Ownership Plans (ESOPs) to convert some of their illiquid privately held company stock into cash and other liquid investments. A partial ESOP strategy is particularly relevant for business owners who want to continue operating and owning a portion of their business while diversifying assets, a prudent part of personal wealth management.
Over the past twelve to eighteen months, we have heard considerable discussion about how the economic downturn has affected valuations of private companies. All of us who have 401ks understand the volatility of public company valuations. Private company values have been affected similarly. However, some valuation professionals have instituted the “smoothing” method to lessen the market volatility on business valuations.
This year is expected to be full of opportunity for many privately held companies, including those owned by Employee Stock Ownership Plans (ESOPs). An essential component for companies to take advantage of these opportunities is a proper capital structure.
The challenges that many of the country’s banks are experiencing are very well publicized and are affecting financing for companies of all sizes and across all industries. Some companies that were once coveted credits of the banking industry are now having trouble renewing senior facilities or are having them renewed under more onerous terms in spite of continued performance. Banks have also pulled back on the amount of financing they are extending to buyers of companies that want to rely on financing to support the purchase (exhibit 1). This has had several effects on the M&A market; lower transaction multiples, more reliance on equity as capital for the acquisition and higher return expectations on investments.
During these unprecedented economic times, the use of an ESOP can provide business owners a unique path to liquidity and increase the cash flow of the business. The goal of liquidity is a challenge in today’s market due to stricter underwriting standards by lenders and buyers cautiously approaching acquisitions.
As an investment banker who works with Employee Stock Ownership Plans (ESOPs), I was surprised when The New York Times recently published an article quite critical of ESOPs. The Times seems to suggest that US Sugar workers were “cheated out of money that was rightfully theirs” because of an ESOP.
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