Why do ESOP transactions cost so much? The truth is they don’t have to.
The timing for the ESOP transaction can be largely managed and expedited by the client. There are several things that the client should and must do to move the transaction and its advisors forward and manage costs. The faster the company comes to grips with these and other alternatives the faster the transaction can close.
The company has to get its forecasts in order. This means in many cases having your financial statements prepared by CPAs on at least a reviewed basis. Some advisors may not require it, but in many cases, it is very important for multiple legal reasons. Get started on those right away if they are internally prepared or compiled. Quality forecasts are necessary for valuation and financing to efficiently determine whether the ESOP trustee’s vision of the transaction meets the seller’s objectives. Financial risk or reliability can affect value.
Many smaller companies do not have the tools ready to prepare these numbers so a template may be available from your advisor to complete this task. The ESOP appraiser will not create these for you.
Selecting trustees, the plan administrator, and other advisors to complete the deal can take time, but should be done quickly to not delay a deal when they come in and have to pick apart an already baked transaction. Sometimes this takes a long time based on RFPs or not knowing what the advisors bring to the table. However, not having them all in place while the deal is being constructed delays issue spotting and can create redundancies in addressing them.
The company has to make decisions about financing. Applying for a loan with a bank can be a time-consuming process. In recent years, it has become maddeningly slow. Bank processes for approving loans can be a black box. Loan committees often know less about ESOP transactions than the loan officers trying to win your business.
The company should set a strict timeline for potential lenders to deliver an expression of interest, a term sheet, an ultimate legal review, and closing the loan. There are qualifying questions you need to ask the bank to see if it is really a player in the ESOP lending arena. Many will tell you they are, but very few are real ESOP lenders. Ninety-plus percent of banks are not. Do not wait on your local lender. Go out to multiple banks all at once. The National Center for Employee Ownership has recently created an ESOP financing resource center for its members that will help with all of these borrowing issues.
Finally, the company and seller have to make decisions about what they want the transaction to be. Do they want it to be a 1042 rollover transaction? Has the seller modeled the portfolio with a 1042 investment expert? In our experience, clients are often slow to get this analysis done. They do not understand it and most do not have an investment advisor on board. To make it worse, there are only a handful of qualified experts nationwide that do this type of financial planning. Get the referrals and get started.
Due Diligence Data
Finally, the company needs to produce the due diligence data and documentation. It needs to produce potentially voluminous data for the attorneys, trustee, and appraiser. No trustee worth their salt will approve the transaction without adequate due diligence and documentation by its counsel.
We recommend that a person or parties within the organization be specifically identified to produce the due diligence documentation. Financial due diligence will be provided to the appraiser first. The factual and legal due diligence for the attorneys and the trustee are absolutely critical and often lags in the deal process.
The trustee’s decisions aren’t simply that the transaction is at no more than fair market value. The trustee must make a determination that the transaction is prudent. The trustee bears personal liability for these decisions. The risk factors inherent in the due diligence help determine whether or not the trustee cannot agree and approve the transaction as being prudent.
Get started on these tasks all at once, and upfront, and you can push the transaction faster. It will help you manage your advisors and help them deliver their work product as promptly as possible.