Transcript Planning for ESOP Repurchase Obligations

Planning for ESOP Repurchase
Obligations
The Ohio Employee Ownership Center
Annual Conference
April 21, 2006
Akron, OH
Judy Kornfeld
ESOP Economics, Inc.
215.546.6590
www.esopeconomics.com
© Copyright 2006 ESOP Economics, Inc. All rights reserved.
Introduction
• Repurchase obligation planning cannot occur in
a vacuum – it must be integrated into the overall
corporate financial planning process
• The process is often iterative, as repurchase
obligations affect earnings and cash flow – and
consequently the resources available for growth
• Repurchase obligations may also affect the
share value
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The goal
• To develop a strategy for how the
company will meet its obligations to its
employee owners and, at the same time,
to maximize the value of the business to
its shareholders
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Components of the planning process
• Forecast repurchase obligations (“repurchase
obligation study”)
• Incorporate into corporate financial projections
• Determine sufficiency of resources
• Adjust ESOP distribution policy if appropriate
• Develop funding strategy
• Test robustness of strategy
• Monitor, update and adjust the forecasts and
strategy regularly
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The process is iterative
Stock Value
Earnings and
Cash Flow
Combined with
Demographics
and Distribution Policy
Repurchase
Obligations
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Forecasting repurchase obligations
• To quantify them, you need to do a
repurchase obligation study
• This is a long-term projection of ESOP
distributions and the associated cash
requirements that the company will face
• It is based on assumptions about a
number of variables
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The forecasting process
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Acquire software or build model
Define scenarios
Develop assumptions
Do projections (integrate with corporate
financial projections)
Analyze results
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Key variables
• Timing of repurchase obligations is
affected by
– Distribution policy
– Demographics (age distribution)
– Turnover
• Amount is affected by
– Account balances
– Stock value
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Good assumptions are essential!
• Assumptions need to be:
– Reasonable
– Internally consistent
– Consistent with other financial planning
• Get “buy-in” on the assumptions from key
members of management
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How reliable is the forecast?
• Projecting multiple scenarios is essential!
• How do you define the scenarios?
• Statistical models are not appropriate for
this purpose
• Scenario planning is a more useful
approach
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Developing a strategy
• How large are repurchase obligations relative to:
– Cash flow?
– Earnings?
– Payroll?
• Can repurchases be handled without interfering
with growth?
• Should changes in the distribution rules or other
plan rules be considered?
• What funding methods are appropriate?
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Components of a repurchase obligation
strategy - distribution policy
• Modifying distribution policy
– Delays vs. immediate payouts
– Installments vs. lump sum payouts
– In-service distributions
– Redeeming vs. recirculating
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Components of a repurchase obligation
strategy - funding methods
• The main methods for funding repurchase
obligations are:
– Pay-as-you-go
– Cash accumulation in ESOP
– Sinking fund in corporation
– Corporate owned life insurance (COLI)
– Debt
– Internal market
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Developing a funding strategy
• To what extent can repurchases be handled
out of current cash flow?
• Is some sort of advance funding (sinking
funds or insurance) necessary and feasible?
• Will it be necessary to use debt or look to
third party solutions to meet the repurchase
obligations?
• How does the funding method affect
– Company’s cash flow and earnings
– Valuation
– Participants’ benefit levels
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Understand the limitations of your
strategy
• Test the robustness of the repurchase
obligation strategy in some “what if”
scenarios that are more optimistic and some
that are less optimistic
– Under what range of scenarios will the strategy
succeed?
– Contingency planning is appropriate if the
strategy is not viable under some scenarios
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Keep planning, stay nimble
• Externalities can change rapidly and
unexpectedly
• You need to be nimble in responding to
externalities, and corporate strategies
(including repurchase obligation strategies)
need to be flexible
• Planning is an ongoing, dynamic process
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In closing . . .
• Begin planning early in the life of the
ESOP
• Forecast the repurchase obligations using
a range of assumptions
• Develop a plan for managing and funding
the repurchase obligation and test its
robustness
• Review and update your strategy regularly
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