1. Be signed into the virtual platform under your email you registered with
2. Fill out the 3 polling questions
3. Submit the CE survey
At the end of the discussion, you will be able to:
1. Identify types and characteristics of capital available to ESOP-owned companies
2. Understand key trends and themes that are currently impacting the capital markets
3. Learn best practices for companies when seeking capital
• What are the general types of financing available?
• Are the capital market conditions favorable today?
• How do I know how much third-party capital to obtain?
• Is financing an ESOP-owned entity different from conventional ownership structures?
• Are there capital providers that know ESOPs?
• How do I prepare for a financing? What can I expect?
Other questions from the audience?
III. Company Preparation and Financing Process
IV. Appendix
a) Forms of Capital
i. Senior Debt
ii. Junior Capital
1. Are you with a current ESOP Company?
2. Are you exploring a new ESOP transaction?
3. How long does a typical ESOP transaction take to execute from start to finish? (1-3 months, 3-6 months, 6-9 months, 9-12 months)
4. Who will be the #1 pick in the NFL Draft tomorrow?
o ESOP Transaction
o Refinance Seller Notes
o Accelerate prepaying Seller Notes
o Reduce overall cost of capital
o Working Capital
o Support Company growth
o Repurchase Obligations
o Growth/Acquisitions
REVOLVER
TERM LOAN A PRIVATE PLACEMENT NOTES (SECURED & UNSECURED)
SENIOR DEBT
TERM LOAN B SENIOR SECURED NOTES
2ND LIEN TERM LOAN
SENIOR SECURED & UNSECURED NOTES
SENIOR & JUNIOR SUBORDINATED NOTES / MEZZANINE DEBT
JUNIOR DEBT
CONVERTIBLE DEBENTURES
PREFERRED STOCK
COMMON STOCK
How much debt/capital to take on?
- Only as much as can be repaid/refinanced
- Only as much as the market will accept
1042 Considerations
- Feasibility study analysis
- Cash at closing and seller note financing
- Need at least 25%-30% cash at closing (or personal liquidity) to execute a 1042 election strategy*
*must be C-Corp selling shareholder
*must sell at least 30% combined ownership
Floating Rate Notes (1042)
ESOP Monetization Loan
$20,000,000 – FRN Holdings
Pays Interest Income
($18,000,000 – Monetization Loan)
Charges Interest Expense
Investible assets
$18,000,000 (minus seller note)
Earns Interest, Dividends and Capital Gains
Notes: The amount of funds to be invested will be reduced by the amount of any seller notes used in the financing of the sale. If interest expense exceeds interest income there is a cost to the holdings. If all holdings are held in the estate of the Seller, the heirs can sell the FRNs (for a likely permanent deferral of the capital gain) and pay off the monetization loan. The taxation of these transactions should be determined by consulting with qualified tax counsel.
1042 election/portfolio value:
Cashflow model
Presented by:
$20,000,000 Joseph Gilbert
Floating Rate Note (FRN) Portfolio Senior Financial Advisor - Investments
Purchasing Model Wells Fargo Advisors
Day 31 after purchase Additional cash Amount of Leverage available needed for next FRN Purchased (for next FRN purchase) purchase
Assumes: Capital Gains rates - Federal (20%), Medicare Surtax (3.8%), Maryland (5.8%)
At least seven new issue FRNs available during election window No outside cash factored. Additional external liquidity provides more flexiblity Disclaimers and Disclosures:
*Market values of FRNs, and therefore loan values, may change. Monetization loan interest will apply to outstanding loan balance. Investments in floating rate fixed income securities are subject to market, credit and other risks. Credit risk is the risk that an issuer will default on payments of interest and/or principal. This risk is heightened in lower rated bonds. If sold prior to maturity, fixed icome securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity. For illustrative purposes only. Information does not prepresent any specific yield, or return or the experience of the individual investors. The illustration is based on law as of 2023. Investors should consider possible changes to tax laws and other risks.
Wells Fargo Advisors is not a legal or tax advisor. Be sure to consult your own tax advisor and investment professional before taking any action that may involve tax consequences. Investment and Insurance Products are:
•Not Insured by the FDIC or Any Federal Government Agency
•Not a Deposit or Other Obligation of, or Guaranteed by, the Bank or Any Bank Affiliate
•Subject to Investment Risks, Including Possible Loss of the Principal Amount Invested
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company CAR# 1221-00284
o Rising inflation and the post-pandemic recovery have caused the Federal Reserve – as well as other sovereign banks – to indicate rate increases in the near-future, which will drive borrowing rates up
Lowerlongtermratestypicallysignallikelihoodofrecession
o Capital markets are tightening, driven by a higher rate environment, worries of an impending recession, and general wariness to deploy capital
o U.S. Leveraged Loan issuances dropped considerably in 2022, with Dec. 22 volume 48.0% lower than Dec. 21 levels. In 2023, rising interest rates and persistent inflation continue to impact lender appetite
o Spreads widened in Q4 2022
o Spreads will vary based on the financial health of the borrower, use of proceeds, and capital provider
o Leverage levels decreased in the back half of 2022
o Today, leverage remains below levels experienced in late 2020 and 2021
Assuming
Assumptions:
Loan amount estimated at 90% of face amount of Qualified Replacement Property (QRP) Portfolio
Hypothetical Bank Loan Rate = Daily Simple SOFR plus 75 basis points
Assumed current yield on hypothetical QRP portfolio
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in a decline in the bond's price.
Credit risk is the risk that an issuer will default on payments of interest and/or principal. This risk is heightened in lower rated bonds. If sold prior to maturity, fixed income securities are subject to market risk.
All fixed income investments may be worth less than their original cost upon redemption or maturity.
Yields are given as of 03/10/23
The above summary of prices/quotes/statistics contained herein has been obtained from sources believed to be reliable
Bonds are subject to price and availability but is not necessarily complete and cannot be guaranteed. If capital gains or realized results only are shown, please Additional information is available upon request be advised that current total account performance may be affected by unrealized losses or gains. This is not a substitute Investment and Insurance Products are: for a Verification of Deposit (or similar form) or the official statement of account holdings at the firm.
• Not Insured by the FDIC or Any Federal Government Agency
• Not a Deposit or Other Obligation of, or Guaranteed by, the Bank or Any Bank Affiliate
• Subject to Investment Risks, Including Possible Loss of the Principal Amount Invested
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC CAR# 1221-00284
o Calculate asset-based borrowing capacity
Apply market advance rates to working capital and PP&E
o Calculate senior and total leverage capacity on a cash flow multiple basis
If generating >$5mm of EBITDA annually, apply going market multiple (i.e., 2.5x – 3.0x)
Depending on industry and exposure to volatility in economic cycles, most borrowers may assume an additional 1.0x – 1.5x of junior capital above the senior tranche
o Most importantly, measure your fixed charge coverage ratio quarterly (multiple of net cash flow to obligations)
ESOP tax savings should help!
o Raising capital is a Board, not Trustee, decision
o Identify total financing needs (including excess availability)
o Prepare a five-year business plan forecast
o Review state of accounting records and financial control systems
o Be prepared to market your company as you would your products and services
o Package = Present the request in an organized way
o Storytelling – why this is the right deal?
o To Debt Providers – key words are safe/secure/defensible/downside protection
o To Equity Investors – key words are growth/scale/synergy/upside potential
o Financials – numbers must make sense
o Due Diligence matters especially in current market condition
o CPA
o Accounting Due Diligence
o Tax Planning
o Lawyer
o Legal Due Diligence
o Documentation
o Investment Banker
o Valuation & Negotiation
o Deal Packaging
o Process to Source Options
o Close the Deal
o Wealth Advisors
o Liquidity management / estate planning
o Attest (Audit or Review)
o AICPA, PCAOB, and COSO Standards
o Provide an opinion and need to be independent
o Generally Accepted Accounting Principles (“GAAP”)
o Historically focused
o Materiality based; Sample selections based on testing
o Fiscal Period Focus
o Consulting / Diligence
o AICPA Consulting Standards
o Advisory role providing fact/judgement-based findings
o “Normalized EBITDA” over GAAP
o Forward looking
o Monthly Focus for Trend Analysis
o Concentration Risks (Customers, Vendors, Employees)
o One-Time Events (Revenue or Expense Normalization)
o Working Capital & Cashflow Management
o Discretionary Expenses
o Market Rate Compensation or Rent
o Post Close Management
o Changes in Accounting Policy or Estimates
o Contractual Requirements
o EBITDA
o GAAP Compliance
o Changes in Current Products or Customer Situations
o Pro Forma Analysis
o Non-recurring Revenues, Expenses, Gains, and/or Losses
o Discretionary spending
o Working Capital
o Seasonality
o Agreement Definitions
o Seasonal Trends
o Adjustments (GAAP, Normalization, Pro Forma)
Investor Size
Commercial banks
Advantages
Maturity
Amortization
Pricing/Returns
Typical Covenants
Tied to appraisal of assets with applicable advance rates
Higher advance rates on inventory and PP&E
Lower cost
5 years
Straight line for term loans
Bullet for revolver
Limited covenants (FCC)
Considerations
Appraisal costs/field exams
SOFR + 1.50%-2.25%
More reporting possibly weekly or daily
Debt capacity tied to the balance sheet
Springing fixed charge coverage ratio
Maximum Capex
Minimum working capital
Commercial banks
Investor
Size
Maturity
Amortization
Pricing/Returns
Typical Covenants
Typically tied to working capital assets or hard assets
Potential for cash flow loan
3 to 5 years
Straight line (typical)
Potential excess cash flow recapture (if cash flow loan)
SOFR + 2.0%-4.0%
Advantages
Low cost
Largest source of capital
Relationship oriented
Considerations
Limitation on leverage based upon collateral coverage
Multiple financial covenants
Total senior leverage: 2.0x – 2.5x LTM EBITDA
Minimum fixed charge coverage greater than 1.2x
Finance companies/ CLOs
Investor
Size
Based on cash flow and enterprise value (min EBITDA of $5 million)
Advantages
Higher leverage
Based on the enterprise value of the company
Maturity
5 years
Back-ended
Amortization
Pricing/Returns
Typical Covenants
SOFR + 7.0-10.0%
Considerations
Higher Pricing
SOFR floor
More restrictive covenants
Max Senior Leverage: 3.0x-3.5x
Max Total Leverage: 3.5x-4.0x
Min Fixed Charge Coverage: >1.2x
Minimum EBITDA
Maximum Capex
Junior Capital
Subordinated Debt
(Mezzanine)
Junior /Seller
Subordinated Notes
Convertible
Preferred
Investor Size
Mezzanine Funds
Advantages
Maturity
Amortization
Pricing/Returns
Typical Covenants
Based on cash flow and enterprise value
Bullet Amortization
Looser/almost no covenants
Long Term capital
5 to 7 years
Bullet at maturity
Maximizes leverage
Cash: 10.0%-12.0%
PIK: 2.0%-4.0%
Warrants: 0.0%-10.0%
All-in-Return: 12.0%-18.0%
Considerations
Higher cost of capital
Prepayment penalty
BOD observation rights
Equity Dilution
Maximum Total Leverage: ~4.0x
Mezzanine Funds
Advantages
Investor
Private Equity
Selling Shareholders
Fewer covenants
Lower cash option
Size
Maturity
Amortization
Pricing/Returns
Based on cash flow and enterprise value
Patient capital
6+ years
Bullet at maturity
Considerations
Equity dilution
Structure based on returns of 12.0%-18.0%
Current pay of 3.0%-12.0% (as permitted)
PIK possible
Warrants to achieve all-in return
Prepayment penalty
BOD governance rights
Subordination rights differ for institutional junior subordinated notes
Loren Rodgers Executive Director
National Center for Employee Ownership
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3. Submit the CE survey
Employee ownership makes the world better.
• Better company performance • Financial security for employee owners
Lower quit rates • Locally rooted economics
But that’s not enough.
What makes it feel real?
• If someone acts like an owner, she’ll start to feel like an owner.
• It sneaks up on people.
• “Click!”
Employee Ownership Month: Four Tips from the Pros
1. Instead of talking about “retirement,” focus on “wealth building”
2. Account value can matter more than stock price
3. What’s a six - letter word for something every ESOP company does?
Blog post: Employee Ownership Month: Four Tips from the Pros
4. Invite guests
Strongly Disagree Strongly Agree
Generally speaking, I understand the ESOP idea and how it works at this company.
Strongly Disagree Strongly Agree
Generally speaking, I understand the ESOP idea and how it works at this company.
Value (of my own account!)
How does it grow?
• Can I lose it?
When do I get it?
What form do I get it in?
How risky is it?
See the Employee Ownership Report, May-June, 2008, p. 3.
• BP has about 3,140,000,000 shares
• The value of one BP share on the New York Stock Exchange
April 20, 2010 $60.48
June 17, 2010
$31.71
April 20: $60.48 x 3.14 billion shares = $190 billion
June 17: $31.71 x 3.14 billion shares = $99 billion
Thanks to Yahoo! Finance
To decide, you need to think like an appraiser.
How much are comparable assets worth on the market?
How similar are those comparable assets?
How important are the differences?
The value of the house
“What the buyer pays for the house.”
The value of the ownership in the house
“What the seller ends up with after the sale.”
Ownership Value = House Value minus debt.
If the ESOP did not own your company,
who would?
• Be patient
• Talk with peers at other companies
• Track the small signs
• Build a rhythm
• Assemble a group
Joel Davis, Vice President of Consulting Principal Financial Group ® Minneapolis, MN Cell: 651-302-8218
Davis.joel@principal.com
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• Understand the requirements for receiving benefits under the ESOP as well as the pros and cons of alternative approaches
• Identify and discuss alternatives to plan rules based on a company’s objectives
• Explain the roles of all parties in the ESOP plan design process
• Questions – Ask them as you have them!
• ESOP plan rules are typically established at ESOP formation
• Focus at the time is closing the transaction – negotiating purchase price, deal terms, etc.
• ESOP rules are often afterthoughts
• Re-evaluate plan rules as the plan matures
• Are they meeting your objectives?
• Do you understand your other options?
• How do you evaluate impact of changes?
Age requirement
• Maximum is 21
Service requirement
• Maximum is 1 year if using a vesting schedule
• May require 2 years with full and immediate vesting
• Very unusual
• Option of more liberal rules for the first plan year
Certain classes may be excluded as long as the plan can meet coverage and participation requirements:
• Union Employees
• Non-Resident Aliens
• Leased Employees
Must enter the plan the earlier of:
• The first day of the plan year which begins after the date the employee completes the statutory age and service requirements, or
• Six months following the date the employee completes the statutory age and service requirements
Rethinking eligibility
• Do you regularly hire employees who are younger than 21 years old?
• Does the plan cover the desired employee groups?
• Does the service requirement still make sense?
Rethinking plan entry rules
• Is the ESOP too intangible for newer employees?
• When have employees waiting long enough?
• Impact of changing entry rules
Service Requirement
• Typically 1,000 hours of service
Employment Requirement
• Typically must be employed on the last day of the plan year
May be waived for death, disability, and retirement
Plan must have a definite allocation formula
• Proportionate to each participant's compensation
• Points allocation based on compensation and service
• Per capita
Plan must define compensation
Definition – Many common definitions are “safe harbor”
definitions
Most common exclusions
• Overtime
• Bonuses
• Commissions
• IRS limit: $330,000 (2023)
Include full-year compensation for participants who enter the plan mid-year?
Rethinking allocation rules
• Ongoing part-time employees
• Special allocation formula still relevant?
• Appropriate to incentivize employment through 12/31? (Last day rule)
Rethinking compensation definition and rules
• Align 401(k) and ESOP definitions?
• Include full year pay for initial year of eligibility?
• Be sure to understand the impact of excluding types of compensation, such as –
• Excluding commissions for salespeople
• Excluding bonuses to “levelize” allocations
New ESOPs almost always include the same basic distribution language (see below)
• No later than the plan year following the event
Other termination
• No later than sixth plan year after the plan year of termination
• Can be delayed further with leveraged ESOPs in some cases
• Most ESOPs allow for distributions in the form of shares or cash
• Company determines form of distribution, subject to specific situations
• ESOP participants may have a right to demand distribution in the form of stock (subject to “put rights”) unless –
• Charter or bylaws restrict the ownership of substantially all outstanding employer securities to employees or to a qualified plan trust;
• Plan Sponsor is an S Corporation (although an S Corporation may still distribute stock with the requirement that it be immediately sold to the company or ESOP); or
• Banks that are prohibited from purchasing their own stock.
• Lump Sum
• Installments
• Over a period not exceeding 5 years
• Longer time frame for large balances
According to the IRS, reshuffling is “the mandatory transfer of employer securities into and out of plan accounts, not designed to result in an equal proportion of employer securities in each account.”
Reshuffling and “segregation” are often used synonymously.
• The accounts of terminated participants in assets other than company stock so they don’t continue to share in the appreciation of the company. This practice is sometimes called segregating terminated participants’ accounts.
• Terminated participants receive other investments from active participants in exchange for stock. Active participants receive stock from the terminated participants in exchange for other investments.
• Limited by cash in plan
Rethinking distribution commencement rules
• Understand “commencement date” is typically when the participant must be offered a distribution, not required to take a distribution
• Understand the impact of delaying the participant’s right to request a distribution
• Does plan allow forced distributions if vested account balance is $5,000 or less?
Rethinking form of distribution rules
• Does plan allow company to pay in shares or cash?
• Does plan allow participants the right to choose stock or cash?
Rethinking form of distribution rules
• Does plan allow company to pay in shares or cash?
• Does plan allow participants the right to choose stock or cash?
• Impact of redemptions v. recycling on repurchase, and imbalance of shares within the plan
• Difference with minority v. 100% ESOP
Rethinking distribution methods
• Analyze the balance of protecting the company’s cash flow with paying participants sooner
• Understand options and best practices
Rethinking reshuffling/segregation rules
• How are segregated, non-stock assets invested?
• Accelerate payment commencement timing for segregated assets?
• What if only a portion of the total terminated participants’ account balances can be segregated?
415 Testing (Maximum Annual Additions)
• Lesser of Contribution or Fair Market Value of Shares Released
• Limitation Year
• Correction method
410(b) Coverage Testing
• Limit Highly Compensated Employees (HCEs) to Top Paid Group
• Include failsafe language
409(p) Testing
• Include provisions to make sure test passes
• Regular check-ins with professionals if concerns exist
Best practices:
• Interest of plan participants
• Multiple perspectives in the room
• Regular meetings and coordination between advisors (TPA, legal, valuation)
• Clear decision process (and parties) for making changes to the plan
• Board approval
The Presenters gather their data from sources they consider reliable; however, they do not guarantee the accuracy or completeness of the information provided within this presentation. The material presented reflects information known to the Presenters at the time this presentation was written, and this information is subject to change. The Presenters make no representations or warranties, expressed or implied, regarding the accuracy of this material. The views expressed in this material accurately reflect the personal views of the authors and do not necessarily coincide with those of their employers.
The Presenters do not provide accounting, tax or legal advice. The information and material presented herein is provided for educational and informational purposes only and is not intended to constitute accounting, tax or legal advice or to substitute for obtaining accounting, tax or legal advice from an attorney or licensed CPA.
Martin Drake and Stevens & Lee are not affiliated with any company of the Principal Financial Group®.
Pros and Cons: Rebalancing, Account Segregation, and Early Diversification
Dan Markowitz, CPA Partner Boulay PLLP
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• What is Repurchase Obligation?
• Distribution Policies Options
• What is Segregation and Options? •
Why Use Segregation?
Case Study
Alternatives to Segregation
• Terminated participants request a distribution according to the terms of the ESOP and/or a distribution policy
• A number of factors that lead to repurchase obligation
• Distribution policy, demographics, stock price growth, etc.
• Repurchase obligation is another form of debt
• Timing of Repurchase Obligation
• Repurchase obligation is small in the earlier years
• Mature ESOPs typically have significant repurchase obligation
• Repurchase obligation is driven by the length of the internal loan
• Longer the internal loan, the less shares allocated each year
• Growth of the Company
• The higher the growth rate, the higher the repurchase obligation
• Timing of distributions will have an impact on repurchase obligation
• How quickly are shares reallocated from terminated participants to active participants, assuming the ESOP provides for segregation
• Role of management and Board of Directors
• Other Plan Provisions
• Continuous review of plan provisions
• Important to monitor repurchase obligation
• Repurchase Obligation/ESOP Sustainability Studies
• Distribution Policy
• Review every three to five years
• ESOP Sustainability
• What are the other strategic initiatives of the Company
• Retirement, Death, Disability
• No later than 1 year after plan year in which termination took place
• All other terminations
• No later than 6 years following the plan year in which termination took place
• Diversifications
• Comes into play when a participant has 10 years of plan service
• In Service Distributions
• Typically for individuals who hit normal or early retirement age (as defined by the plan)
• Lump Sum
• Installments over a period not to exceed five years
• Extend for up to another 5 years for large account balances
• Stock distribution
• Subject to automatic put option
• Payment comes form the company
• Effect on current and future valuation
• Reducing the number of shares outstanding
• Obligation of Company
• Cash in the ESOP vs. Company
• 80-26 loan to the ESOP
• Administration loan to fund distributions
• Short-term in nature
• Contributions to the ESOP
• Redemptions by the Company
• Dividends to the ESOP
• Need to monitor who is benefiting
• Managing repurchase liability often requires managing an ESOP’s Distribution Policy, if there is one (considered part of the plan document, and any changes require a formal plan amendment)
• Unlike other types of qualified retirement plans, ESOPs are generally permitted to change the timing and form of distributions
• This allows ESOPs to manage repurchase liability by extending payment terms or limiting lump-sum distributions
• Review every 3 to 5 years
• Segregation is the method of using available cash in the ESOP to exchange shares of company stock into an alternative investment within the plan (Company decision)
• Many companies have this provision in their plan document in order to avoid terminated participants reaping stock appreciation after they leave
• Also, a way to get more stock back to active participants and not dilute the ESOP
• A particular form of investment is not a protected benefit
• IRS approves of segregation, provided:
• ESOP terms authorize such actions and have a definitive formula for determining how many shares are segregated, how the price at which such segregation will be determined, and to whom the shares are to be allocated
• Must be nondiscriminatory
• Plan administrator or other fiduciary may not use discretion to pick and choose which accounts may be segregated
• Application of segregation is within the plan document
• Must be adequately communicated to ESOP participants
• New ESOPs
• Almost all new ESOPs are including segregation in their initial document
• Actively using segregation because stock price is low
• Mature ESOPs
• Adding segregation to their plan document
• Starting to actively use segregation
• Cash requirements can be significant
• Staged approach
• Pro-Rata – Across all individuals eligible for segregation
• Participants may be invested in company stock and alternative investments
• Ordering by earliest termination date
• First in, first out method of segregation
• Segregate full balances
• Ordering by type of termination
• First - non-retiree terminations by termination date
• Retirees by termination date
• Segregation of accounts prevents former employees from sharing in future gains
• Segregation of accounts protects former employees from sharing in future losses
• Speeds up the repurchase obligation to the time of segregation
• Can transfer the segregated accounts to company’s 401(k) plan or make the segregated accounts participant directed (reduces fiduciary risk)
• Segregation can also free up more shares for allocation – helps with the “Haves and Have Nots” issue
• What does management believe?
• Increasing stock vs. decreasing stock
• Philosophic discussion
• Who is benefiting – active vs. inactive participants
• Repurchase obligation is another form of debt
• How fast is the stock appreciating?
• Immediate payout of segregated accounts is typical
• Use of existing Distribution Policy which clearly outlines the segregation process
• Trustee responsible for managing segregated accounts
• Pooled account vs. participant-directed investment
• Alternative investment within the plan
• Preserve capital with a return on the investment for participants
• Investment choices subject to the investment policy statement
• Company had a “RIF” in 2008/2009
• A significant turnover event
• Employees went to work for a competitor
• As of December 31, 2015
• 50% of the stock was allocated among terminated participants
• Distribution Policy
• 5-year wait; 5-year installments
• Participants were not requesting distributions
• Stock price annual growth from 2010 – 2015 was 15%-30%
• Installment payments were not covering the appreciation
• Terminated participants were not requesting distributions
• Return on the Company stock
• Total amount held by terminated participants = $13 Million
• Contributions = 15% of eligible compensation
• Contributions just covered current year distributions
• 2016 Approach
• Current year distributions were paid via stock distributions
• Current year contribution (15% of eligible wages) was used for segregation
• Allowed to fund two years of repurchase obligation funding in one year
• Term debt to fund the stock distributions
o Company made stock contributions over 5 years
o Allowed shares to be put back in circulation
• 2017 – 2020
• Company performance remained strong
o Stock price doubled in 4 years due to significant growth
o Only part of the contribution was being used for segregation
o Part of current year distributions funded by the previous year contribution
• Active participants benefit
o Held the majority of the outstanding shares (morale improved)
o The value accreted to the active participants
• 90% of the stock was held by active participants
• Saved the Company over $10 million in the short term
• Terminated participants started to request distributions
• Morale improved among current employees
• Company had significant growth, which was projected in 2016
• Allowed the Company to fund strategic initiatives
• Distributions in form of stock with put to the Company
• This is essentially a redemption with payments from the Company made directly to former participants who receive distributions in the form of stock, pursuant to the put option requirements
• Reduces the number of shares outstanding
• Can artificially increase the stock price in future years
• The shares can be contributed or sold back to the ESOP
• Stock contributions
• Re-leverage transaction
• Provide for a non-statutory diversification to participants
• Pros of Early Diversifications
• Allows participants access to account balance sooner
• If share price is increasing, allows company to “pre-pay“ repurchase obligation
• Employees don’t leave the organization to receive their funds
• Can recycle more shares to newer and younger employees
• Cons of Early Diversifications
• Immediate cash need
• Accelerates expected repurchase obligation
• Reduce cash available for other strategic initiatives
• If a down year, may see an increase in diversifications
• Each year, the ESOP accounts are rebalanced so that each participant has the same percentage of his or her account invested in employer stock and cash
• Takes from long-term for the benefit of newer participants
• Requires cash contributions
• Must be expressly provided for in the plan document
• Clear communication to participants
• Difficult to implement in mature ESOPs
• Annual Leveraged
• Instead of recycling the shares distributable to former participants in one year, why not stretch the allocation of these shares over several years?
• Could accomplish this by distributing shares to former participants and having the ESOP acquire such shares using the proceeds of an exempt loan
• The form of this transaction is important as the IRS regulations allow an ESOP to borrow as long as the proceeds are used to “acquire employer securities” or to refinance an existing loan
• Downfall - cost of annual releveraging transaction
• Provide for one-time diversification window
• Nondiscrimination requirements must be met
• Can possibly be implemented as different diversification percentages for different age ranges
• Provide for a distribution window offering in-service withdrawals to a group of employees with disproportionately more stock in their accounts, provided nondiscrimination requirements and distribution event requirements are met
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The ability to project gravitas—confidence, poise under pressure and decisiveness—seems to be its
core characteristic…. [C]ommunication—including speaking skills, assertiveness and the ability to read an audience or situation—and appearance contribute to a person’s perceived executive presence.
The ability to project gravitas—confidence, poise under pressure and decisiveness—seems to be its
core characteristic…. [C]ommunication—including speaking skills, assertiveness and the ability to read an audience or situation—and appearance contribute to a person’s perceived executive presence.
…[O]ften times people who exhibit executive presence exude a “wow factor,” or magnetism, and are able to easily influence others. They often speak up, use strong and clear language, communicate with passion and energy, and display positive body language by standing tall, making eye contact, offering a firm handshake and using an authoritative tone of voice.
Go-Do (call to action)
Ella is a transformation coach who offers programs to people looking to make a change in their lives. She has group and individual options. Her clients boast new levels of confidence and achieve their goals more quickly.
Ella is a transformation coach who offers programs to people looking to make a change in their lives. She has group and individual options. Her clients boast new levels of confidence and achieve their goals more quickly.
Ella’s clients boast new levels of confidence and achieve their goals more quickly. Her transformational programs help people make meaningful changes in their lives. She has group and individual options.
“How
Go big or go home
“At the Jan. 20, 2009, inauguration of President Obama, Aretha Franklin's hat nearly stole the show.”
1, 2, 3,
Deana R. Haworth, APR
Chief Operating Officer, Hirons
(317) 977-2206 x 108
dhaworth@hirons.com
LinkedIn: Deana R. Haworth, APR
Grace Dawson
Membership Associate, NCEO
(510) 208-1305
gdawson@nceo.org
LinkedIn: Grace Dawson
1. Scan the session QR Code on the door or directional signage nearby
2. Engage in the session content for all 60 minutes.
3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.
4. Complete the CE Survey.
• Deana began her career as a public relations specialist at Hirons and immediately assumed an upward trajectory.
• Now a 22-year veteran of the agency, she serves as chief operating officer and oversees all departments in the agency.
• As COO, Deana manages all company operations including business development, growth and strategic planning while continuing to serve as a senior adviser on key accounts.
• She is the first female to serve in this role in the agency’s 44-year history.
• Grace Dawson is the Membership Associate at the NCEO, ensuring the continued success of the members by supporting the Membership Director in member communication, digital and print communication, and handling member orders.
• Grace was born and raised on the East Coast and graduated summa cum laude with her BA in Communications from Plymouth State University after transferring from Trinity College in Dublin, Ireland.
With thousands of companies, there are a lot of great tools that already exist for communicating every aspect of employee ownership, from educational games to slide decks, from business-improvement contests to custom videos. Join this session to see examples that will inspire... and that you can take home with you.
1. Understand how to include employee-owners in the planning of Employee Ownership Month activities.
2. Discuss how to integrate resources into your Employee Ownership Month plan and how to communicate them year-round.
3. Gain insights into adopting Employee Ownership Month activities shared by the community.
• Advertising, public relations and digital
• Employee-owned since 2010
• 100% employee-owned since 2013
• Client portfolio split among government and commercial
• 501(c)(3) nonprofit
• Supporting the employee ownership community since 1981
• Our mission: to help employee ownership thrive!
• Membership resources
2010:
• Founder and Board Chair Tom Hirons sold 30% of his ownership shares to be distributed to all long-term team members to form an ESOP
• Leadership team announcement at St. Elmo’s
• Next day all-staff announcement
2013:
Tom sold the remaining 70% of his shares to the ESOP trust
100% employee-owned
35th anniversary party
2018:
• Paid off the ESOP loan and officially debt-free, two years ahead of schedule
• 40th anniversary party
• Leadership transition announcement
•
Recognition/Acknowledgements
• Established Tom Hirons IU Media School Scholarship and Internship at Hirons
• Established Founder’s Day in 2019
• Celebrates our founder, Tom Hirons, and everything we have accomplished in the prior year
• Presented the second payment for the Tom Hirons Scholarship to the Indiana University Media School
• Organized by the Tom Hirons and Amos Brown interns
• All communications should start with research
• Include ESOP-oriented questions in employee-owner, client and vendor/partner surveys
• Research findings become a baseline
• NCEO: The Ownership Culture Survey
• Help with designing
• Remain open for 7-14 business days
• Report includes summary, charts, demographic overview, & NCEO support
I feel like an owner of the company. I feel an obligation to challenge poor performance by my fellow employees.
People recognize that the future value of their [ESOP] accounts depend on the success of the company.
Generally speaking, I understand the ESOP idea and how it works at Hirons.
The person I report to actively seeks my input.
% Favorable Mean
Key point #1: Key point #3: Key point #2:
Supporting points Supporting points Supporting points
100% Employee Owned: Welcome to Hirons. This firm is unlike most others you are likely to work with or visit. Our firm is an ESOP and is owned by its employees.
Our stock was placed in trust by our founder, Tom Hirons. Ownership in the value of the stock is distributed annually to all qualified employees at no cost to them. Whomever you interact with today will likely be an owner.
What does this mean to you?
You are talking to someone who can get things done.
You are talking to someone who cares about your experience and your satisfaction. You are talking to someone who can fix problems, make commitments and carry through with any promises.
If you are interviewing for a job, you are talking to someone who is not just looking to make a hire but also to select a future fellow owner. You are talking to the owner. BE BOLD.
Diversity, Equity and Inclusion Council
• Our Commitment to Diversity, Equity and Inclusion
Learning & Growth Workgroup
• Team Live Well
Customer Workgroup
Financial Workgroup
• Green Team
Internal Business Processes Workgroup
• Team Hirons
• Financial workgroup responsible for building and executing an ongoing employee-ownership communications plan
• Year-round key messages, strategies and tactics
• Updates annually
• ESOP communications are part of the plan, but the overarching goal is to create and sustain a culture of ownership in the agency
• Resources for new ESOPs
• Rollout “mini toolkit”
• ESOP basics
• HR, business owners, decision makers, participants
• Recruitment & Retention Toolkit
• Communicate value of EO to potential candidates
• Find employees
• Onboarding/1st year
• Retention
January
• New ESOP member money tree
March
• ESOP Brunch with the board
June
• Founder’s Day Celebration
October
• Ownership month recognition
• 100% vested vests
• Trustee-hosted training
• Merchandise program
• Dog-friendly
• Themed events
• Holiday celebrations
• Competitions
• Donation drives
• Block clean-ups
• Friday breakfast • Friday Fun
What do you do to engage employees?
• Ownership Culture Survey + networking program
• Communications Committee Crash Course •
Director of Education will be taking over from Dallan
Regular cadence of weekly, monthly and quarterly recognition:
• Bat Awards
• Kudos
• High Fives
cards • Business cards
1. Determine how to include employee-owners in the planning of employee ownership month activities
2. Discuss how to integrate NCEO resources into your Employee Ownership Month plan
3. Gain insights into adopting Employee Ownership Month activities shared by the community.
Deana R. Haworth, APR
Chief Operating Officer, Hirons
(317) 977-2206 x 108
dhaworth@hirons.com
LinkedIn: Deana R. Haworth, APR
Grace Dawson
Membership Associate, NCEO
(510) 208-1305
gdawson@nceo.org
LinkedIn: Grace Dawson
1. Be signed into the virtual platform under your email you registered with
2. Fill out the 3 polling questions
3. Submit the CE survey
• Pandemic Aftershocks
• Inflation
Supply Chain • Labor Supply • Lockdowns, PPP, ERC, etc. • Inflation and Interest Rate Impact on Valuations
• Too Much Demand:
• Fiscal Stimulus (government spending) and Monetary Stimulus (low interest rates) caused the money supply to grow by 37.8% from January 2020 to December 2021
• The growth in money combined with pent up demand from the pandemic drove an extraordinary appetite for goods and services
• Not Enough Supply:
• Inventories were “lean” prior to COVID
• COVID shutdowns, demographics and fiscal stimulus constrained labor output/productivity resulting in supply chain disruptions
• Hoarding of supplies further exacerbated the problem
• Geopolitical events reduced energy supplies
1. Bifurcate (if possible) change in revenues due to production versus price point.
2. How are inflationary impacts reflected in the forecast?
3. How has inflation impacted customer contracts? Are there new items or language in their contracts or proposals that can help reduce the risk
4. Are the inflationary impacts on increasing interest rates preventing the subject company from making investments?
5. Passing along costs
6. Protective language in contracts re: inflationary pressures
1. Discussion of increased costs associated with getting product in a timely manner. Temporary or “new normal”?
2. Has the subject company reached out to new suppliers to help alleviate some of the supply chain burden?
3. Discussion of risk of overseas suppliers
4. How have supply logistics impacted spot purchasing decisions and build- up of inventory
5. Impacts to Net Working Capital based on changes in inventory build- up
1. Discussion of retention of existing labor
• Pay increases, different types of incentives, increase in overall benefits?
2. Discussion of challenges in finding new talent
• Recruiters, employee bonuses, relationships, directly with colleges
3. How is your subject company dealing with increased expenses related to attracting and retaining employees?
4. What is the company workforce’s age distribution?
5. How is capacity to generate revenues impacted by labor trends?
6. Discussion of margin compression as a result of increased labor burden.
• The government-imposed COVID lockdowns impacted businesses, industries, and regions differently
• Airline catering company vs. garbage removal business
• Different states, different policies
• The federal government created the Paycheck Protection Program (“PPP”), the Employee Retention Credit (“ERC”) and other financial safety nets to minimize business closures and bolster employment
• Some companies got the PPP/ERC proceeds even though they did not miss a beat while with other companies suffered operational and financial difficulties that eclipsed any PPP/ERC provided
• How does an appraiser consider this “black swan” event?
• Industry Specific
• How has inflationary pressures impacted your industry?
• Company Specific
• How has the company reacted to streamlining costs and revising purchasing decisions?
• How strong is communication with clients to address cost escalation?
• How does the company’s pricing and purchasing power come into play?
• Contract Specific
• Have the contracts been amended to address rapidly changing material prices and/or delays in jobs?
• The Fed is raising interest rates in an effort to reduce demand with the hopes that this will impede inflation
• The current “inverted” yield: short term rates are higher than long term rates
• Inverted yield curves often are a precursor to a recession and are a prediction that over the longer term the Fed will need to reduce interest rates again to pull the economy out of the recession
• Impact of Interest Rate Hikes on Valuation
• Existing Debt
• If company has existing debt at an interest rate lower than rising interest rates, the FMV of the debt may be lower than face value, having an upward impact on value.
(Ex., Subordinated Debt)
• Overall Cost of Capital of a Company
• To the extent a company requires debt to fund operations/ growth, the cost of debt is factored into the ultimate value of the company
• All else equal, higher the cost of debt, the lower the co. equity value
• Should higher interest rates result in deferral of investment opportunity, the opportunity cost is indirectly reflected in the value of a company.
Guideline Comps
Market Approach/ M&A Comparable Comps
Meaningfully Negative
Meaningfully Negative Slightly Negative
Three Approaches to Value – Income Approach, Market Approach and Asset Approach (asset approach is typically a floor valuation and, thus, we will focus on the Income and Market Approaches
Income Approach – Examines the cash flows of the Company and converts them to value, based on a risk rate. Such risk rate is sourced from the market and is meaningfully higher at 12/31/22 vs. 12/31/21 (which has a negative impact on value).
a. Guideline Public Company – examines market multiples of publicly traded companies as indicators of value. Derived value multiples are then applied to the Company’s cash flows. Such market multiples are meaningfully lower at 12/31/22 vs. 12/31/21 (which has a negative impact on value).
b. M&A comparable method – examines market multiples of M&A deals as indicators of value. Derived value multiples are then applied to the Company’s cash flows. The data for market multiples have not yet had a meaningful movement. However, to the extent that the outlook of companies being acquired is pessimistic, this will eventually have a cooling effect on market multiples.
• Holding all other factors constant, accounting only for the change in market data results in a 17% decrease in the Enterprise Value, based on the changes in market data considered.
• Total Enterprise Value considers both (i) the Income Approach and (ii) the Market Approach (and market inputs that enter into each of those 2 approaches).
• This is an overview of changing ONLY key market factors and assumes all else is held equal, which may not be the case with many companies. Each valuation is very “case-specific”.
• Higher interest rates generally impede more aggressive financing structures
• Banks will want to see greater interest rate protection on floating rate debt through swaps and other hedging instruments
• Sellers receiving seller notes may need to provide more lenient amortization schedules
• Overall rates of return on seller notes may be pushing higher given the overall rate environment (and risk!!!)
• Trustees may way to hedge against “blue sky” financial forecasts with claw backs or earnouts