An ESOP can be a good option for business owners who want to transfer the ownership of their company over time. These are the top four questions we receive from clients who are starting to investigate an ESOP.
How do we find out if an ESOP is a good fit for us?
Whether an ESOP is a good fit for your business depends on financial aspects, taxes, and what the seller wants to do. It’s important to determine whether or not an ESOP is suitable for the company, the seller, the non-selling shareholders, and management. Ask yourself if it’s the right thing to do.
Instead of diving right into the numbers, we prefer to conduct an ESOP suitability review first. For the suitability review, we gather all the necessary data and map out the issues. Then we work with the business to do a diagnostic check of all of the items that we know can come up in an ESOP transaction for each of the constituencies including the company, seller and non-sellers. We identify and analyze trade-offs, compromises, or objections to the transaction that would make an ESOP not a good solution for the company and explore other alternatives.
Once we’ve decided that an ESOP is suitable for us and our company, what do we do next?
When you decide an ESOP is suitable for your business, you are deciding to sell your company or a part of your company to a third-party. The law states an ESOP is treated the same as any third-party that is able to buy the company for cash. The trustee is the party that represents the ESOP on behalf of the beneficiary. The trustee has to determine things like what can the ESOP pay or are there issues regarding due diligence that underlie the company that they are going to have to be explored. You’ll want to decide who should be the trustee, select the trustee or hire a professional trustee, and find out what the potential buyer thinks about the company before you go further in the process.
What about pricing? How much will an ESOP pay for a company?
From the seller’s side, this is the burning question. How much can I get for my company? There are different studies that can be done from the seller side and the company side. The ESOP trustee will need to have a preliminary range of values provided by a qualified, independent appraiser. This is not a complete appraiser report, but it allows the buyer and seller to start the conversation of how they are looking at value. The seller may very well need to get their own appraiser as well.
Ultimately, under the law when the dust settles and you’ve completed a transaction, the ESOP trustee can only pay adequate consideration. If you’re negotiating with a third-party buyer, they are going to come up with a number and you’re going to agree or disagree. It’s not a hard and fast number. Many factors go into this number such as the size of the transaction. Focus on the preliminary range of values, get the discussion started, make sure you are doing a prudent job, and then let everyone say we’re going to move forward based upon this price or price range and start structuring the transaction.
What do we do next? What are the nuts and bolts of putting an ESOP transaction together?
Now that you’ve decided an ESOP is suitable for your company and you’ve brought a fiduciary on board who is going to determine a reasonable range of value for the company to structure a transaction, it’s time to determine feasibility with a feasibility study. Many advisors will say to do the feasibility first, however, we do not approach it that way unless you are considering a very large transaction with multiple levels of debt.
Constructing the transaction, getting it going, and pinning down the design requires you to dive into the essentials of cash flow projections, earnings, and what primarily drives the valuation, and tax advantages of different structures such as a C corporation versus an S corporation to really see if it is going to meet your needs and whether you can finance it. Keep in mind there are many different types of ESOP transactions and ways you can structure and finance them so those are the details you will need to decide during the feasibility analysis. For a smaller transaction, you do not need as comprehensive of a study, but for a large transaction, you will definitely want to dive in and do the work to make sure that all of the features you put in the transaction are going to work and can be sustainable for the company and the seller gets what they need.
Wondering if your company is suitable for an ESOP? Let’s start a conversation.