SESSION TITLE. Fall ESOP Forum So You re Thinking about an ESOP

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1 Assessing ESOP Feasibility Presented by: Peter E. Jones Horizon Trust & Investment Management 100 E. Campus View Blvd., Suite 250 Columbus, Ohio So You re Thinking about an ESOP Great! Now what? Questions You Must Answer Questions You Should Answer Digging Deeper Feasibility/Best Case Analysis Case Studies 2 Questions You Must Answer What do you want to use it for? Will the value an ESOP can pay entice you as an owner to sell? Does the business make enough money? Do you have enough employees/compensation? 3 1

2 What is it good for? Retirement plan/employee Benefit Ownership succession Management incentive 4 Will it provide you value? ESOPs cannot pay more than fair market value Willing buyer/willing seller ESOP is not a strategic buyer cannot realize value do to synergies that a strategic buyer may be able to realize ESOP does not come to the table with money but relies on the creditworthiness of the business and the business s ability to generate cash flow Shareholder expectations Shareholder likely to receive seller note as payment for their stock What is your time horizon (no pun intended) for installments? 5 Does cash flow support the transaction? ESOP doesn t come to the table with money Sources of payment Balance sheet cash (less working capital) Company borrowing Seller Notes Do projected cash flows support financing the price expectations of the Seller? Do you have significant capital requirements that could inhibit ability to repay seller debt? 6 2

3 Employees and Compensation Enough Employees C-corp (number not as important) S-corp (409(p) limitations) Participants or others who are deemed to own 10% in the plan (deemed-owned) become disqualified persons Non-allocation year if disqualified persons own, in the aggregate, 50% or more total equity of the Company Draconian penalties and excise taxes Enough Compensation 404 deductibility (25% of eligible compensation) 415 limits (spread out over employees no more than $55,000 to individual participants inclusive of all defined contribution plan contributions (deferrals, match, employer contributions)) 7 Questions You Should Answer Do you believe in employee ownership? Are you willing to subject your company and your sale transaction to IRS and DOL scrutiny? Are you ready to get outside input into your business? 8 Do You Believe? Not set it and forget it Requires initiative to embrace an employee-owner culture As with anything of value it requires effort 9 3

4 IRS and DOL Scrutiny A transaction between a party in interest (aka disqualified person) and a qualified retirement plan is a prohibited transaction (PT) unless an exemption applies Exemption for acquisition of employer securities if plan pays no more than adequate consideration (i.e., FMV) Loans (also a PT unless the foregoing exemption applies) between a plan and a party in interest are subjected to special scrutiny 10 ESOP Owned v. You Owned Owner Sole Board Member Company CEO/President Employees 11 ESOP Owned v. You Owned Trustee Directed or Discretionary Elects Board Board Appoints Trustee Appoints Administrative Committee Appoints Officers/Management Nominates Board Company Employee/ Participants Limited voting rights 12 4

5 Digging Deeper Feasibility Analysis A jolly-good feasibility analysis what s included? Value Transaction Structures Projection of cash flows Financing terms Estimate of net after-tax proceeds Estimate of timing of receipt of proceeds ESOP Plan Design Estimate of benefit levels to employees (and sellers if participating) 13 Sample 1 A contributory ESOP Engineering firm 15 employees Long time horizon (no pun intended) Company had redeemed one of three owners SBA loan for approximately 30% of firm GOALS: Believe in employee ownership to retain employees Create market for future sale of owner equity Using contributions of stock to create deduction consistent with principal payments on SBA loan Principals to participate in ESOP 14 Feasibility Analysis Relied on value from 2017 SBA loan (required valuation) Identified approximate share contributions needed to create deductible principal from SBA Loan payment and time to get 30% of equity to ESOP Developed share allocation models to show how equity would be allocated among participants in the ESOP Prepared 409(p) testing to address concentration of shares and to inform limitations that may be needed in ESOP Plan Design Demonstrated value to current owners of equity upon repayment of debt including value to owners to be held in ESOP Showed impact of profit distributions to ESOP and how those could be accumulated for future share purchases from current owners 15 5

6 Sample 2 Full ESOP Sale Niche publisher 45 employees Single selling shareholder Has key executives in place GOALS: Looking to be personally out of the business in 3 years Believes in employee ownership Wants to keep Company very safe from debt perspective 16 Feasibility Analysis Estimated value using weighted average EBITDA multiple value (i.e., napkin valuation) also knew what a bank was willing to bankroll Prepared projections with debt-coverage ratios to determine cash available to service debt in the future Identified structure including bank and seller financing Ran various financing structures against projections for debt service With terms to protect Company cash flow, identified seller proceeds and timing 17 Who Does Feasibility Work? Who does a feasibility analysis? Investment bankers/seller financial advisors Third-Party Administrators to the ESOP will do it Lawyers You 18 6

7 What Next? You have decided you want to do an ESOP, now what? Identify providers and costs, some or all of the following: Legal counsel Trustee Independent appraiser (serves the Trustee) Financial advisor to the Seller Third-Party Administrator for the ESOP 19 Questions? Peter E. Jones Horizon Trust & Investment Management 100 E. Campus View Blvd., Suite 250 Columbus, Ohio