Transcript DP_Black Template - Kent State University

ESOP Feasibility
Presented at the 20th Annual
Ohio Employee Ownership Conference
April 21, 2006
ESOP Feasibility - Overview
 Thinking about an ESOP?
 ESOP Considerations
 ESOP Feasibility Issues
 Q&A
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THINKING ABOUT AN ESOP?
Goals & Objectives
 Shareholder Liquidity / Diversification
– Can sell a portion or all equity to an ESOP
 Tax benefits (1042 for seller)
 Employee ownership culture
– Sharing wealth creation capability
– Employee Retirement plan
– Alignment of financial interests between owner & employees
 Continuing legacy of business
 Strategic reasons
– “Friendly”, “patient” shareholder
– Improve company cash flows / liquidity (temporarily), if benefit substitution occurs
 Other?
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THINKING ABOUT AN ESOP?
Characteristics of ESOP Candidates
 Closely held U.S. based company
 Ownership
Tax benefits available to individual owners rather than corporate owners
Corporate owners do not receive tax benefits on sale, but an ESOP can provide significant tax
benefits to the company post-transaction that can facilitate an attractive transaction price
Company can be a C-corp or and S-corp
 Currently section 1042 is only available to individuals owning stock of C-corps
 More than 25 employees
Companies with small payroll bases may encounter 415 limitation problems
 Profitable
As most of the company benefits are the result of tax savings, the company needs to be profitable to
enjoy these benefits
 Debt capacity
Since ESOPs are usually a specialized form of a leveraged buyout, the assets and/or cash flows of
the business need to support the transaction debt.
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THINKING ABOUT AN ESOP?
Characteristics of ESOP Candidates (continued)
 Owners interested in a liquidity event
An ESOP can provide total or partial liquidity to the owner(s)
 ESOP can be formed and provide liquidity for a minority or controlling interest
 For the owner to receive the tax benefits of a section 1042 rollover, the ESOP has to end up
owning more than 30% of the company on a post-transaction basis
 Owners that are interested in diversifying their net worth currently trapped in the business
A minority sale to an ESOP now does not preclude a sale to a third party later
 Owners that are interested in beginning a succession plan can transition ownership to the
employees over time
 Sharing the wealth creation potential
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ESOP CONSIDERATIONS
Business Considerations
 Strength of management team
esp. if owner(s) totally cashing out
 Capital constraints
Operating the business with debt increases financial risk
Market position / growth constraints while servicing debt?
 Culture
Open environment
Communication
 Helping employees understand what it means for them.
 Who will participate?
In sale?
In ESOP?
Post transaction incentive plans for key employees
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ESOP CONSIDERATIONS
Other Considerations
 Governance & Disclosure
ESOP, not individual employees own shares
Trustee – Internal vs. external
 Trustees are not usually active in day to day company operations
Sharing of Information with employees
 Minimum disclosure - employees need to receive a statement annually showing their account
value, do not have to share company financials
 Repurchase Liability
While initial ESOP contributions are cashless, ultimately the vested and allocated shares have to be
repurchased from departing employees, which is a cash out flow of the business.
Repurchases can become a problem when capital is constrained and large blocks of stock are put,
but…
….Repurchase payments can be managed with proper planning
In most cases, no cash payments until after loan is repaid
 ESOPs own stock – STOCK VALUES GO UP AND DOWN
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ESOP FEASIBILITY
Feasibility Study
 Understanding your goals & objectives
 To sell at what price?
Fair market value vs. strategic value
 ESOP is akin to a financial buyer
Control vs. minority
Typical valuation methods
 Comparable companies, DCF, M&A transactions
Ultimately the purchase price based upon active negotiations with the ESOP trustee (who
represents the buyer) and their advisors, and the seller and his/her advisors
ESOP cannot pay more than fair market value!
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ESOP FEASIBILITY
Feasibility Study (continued)
 Tax Benefits
To selling shareholder(s) – 1042 election?
 Need to sell at least 30% to make 1042 election
 Stock must have been purchased to be eligible for 1042
 1042 not yet available to S Corp shareholders
To company
 Contributions are deductible
 C-corp. vs. S-corp. post-transaction
 100% owned ESOP S-corp. creates a tax free entity!
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ESOP FEASIBILITY
Feasibility Study (continued)
 Sizing the Transaction
 Your Goals & Objectives
Total or partial liquidity
Dilution
 Value
 Borrowing capacity (for leveraged ESOPs)
Collateral base
Ability to service debt w/o over-stressing the company, esp. for companies not used to
operating with debt
ESOP provides greater borrowing capacity…with the right lender
Need of Mezzanine or Seller financing?
 Identifying 415 Limitation Issues
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CONTACT
John C. O’Brien
Director
Duff & Phelps, LLC
311 S. Wacker Drive
Chicago, IL 60606
Phone: (312) 697-4545
e-mail: [email protected]
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