Sheryl C. Bayani-Alzona
Employee Benefits Law Group PC 10880 Wilshire Blvd., Suite 1101
Los Angeles, CA 90024
Direct dial: (310) 571-8896
E-mail: scba@employeebenefitslawgroup.com
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4. Complete the CE Survey.
• Why an ESOP? • Plan Design • Administrative Driven Issues • Multiple Plan Design Issues
Fiduciary Duties
Design Alternatives
ESOP Peculiarities
• Goals of the Company and Seller
• The Company’s Employee Pool
• The Transaction Design
ESOPs seek largest number of employees
Therefore:
• More generous eligibility provisions than other types of retirement plans
• Eligibility may be any plan year or 12-month period where employee completes 1,000 hours
• Simplest to "enroll" participants once a year, retroactively as of the first day of the year of eligibility
• Garners largest eligible compensation base in any given year
• Achieves broadest participation base
• Simplest to administer
Crediting Service: Eligibility
Eligibility: Best for ESOP to credit prior hours
• Crediting prior hours of service maximizes number of participants in new ESOP
• Thereafter, one year of service is applied to newcomers
• For acquired companies, typical to count predecessor service
Crediting Service: Vesting
Best for new ESOP NOT to credit prior hours –the larger the plan, the wiser this is
ESOPs typically receive larger contributions than other DC plans
Owner must have liquidity to cash out retiree stock; will want to reward longterm employees
Best to start vesting from scratch
• Depends on the ESOP
• Most DC plans use six-year graded vesting schedule to avoid discrimination testing problems
• Typical number of ESOP participants means plan won't be top-heavy
• Three-year cliff seldom used
Options are very limited
Vast majority of ESOPs allocate employer contributions proportional to compensation
• Points weighted or allocation "rate groups" can be used
• Must pass the average benefits test
• Work with your TPA to run the numbers
Top Heavy Considerations
• Coordination among service providers is important
• ESOPs not often top heavy alone
• Top heavy minimum contribution can be made to ESOP or 401(k)
• Documents should specify (otherwise, may have to contribute to both plans)
• Generally 3% of eligible compensation is minimum
• Already budgeted ESOP contribution may cover it
Coordinating with a 401(k)
• Can match 401(k) deferrals in the ESOP or the 401(k)
• Matching contribution may be made in cash or employer stock
Coordinating with a 401(k)… Cont’d
• Consider ESOP leveraged shares for this allocation
• Consider allocations at dollar amount or stock amount
• ESOP must specify accounting method
Safe Harbor 401(k)/ESOP
• Used to pass 401(k) discrimination tests
• Can be either safe harbor match or 3% non-elective contribution
• 100% vested in ESOP or 401(k)
• Deposit to the ESOP or use loan release shares
• Both plans must comply with the document and notice requirements
• Make sure the plans coordinate
Other Coordination Considerations
• Diversification options (roll to 401(k) plan – three investment options available?)
• Vesting computation period • Limitation year definitions
Other Coordination Considerations… Cont’d
Plan year-ends for fiscal year companies
Is your plan specific enough?
• Separate trust document?
Who is the Administrator per the plan?
Must trustee sign the plan?
Concerns… Cont’d
• Who has power to amend?
• Is there a trustee contract agreement? • What does State law say about shareholder rights?
• Have the fiduciaries read and accepted the document?
•
Who is the fiduciary who, per the plan, has the right and responsibility for accounting and valuations?
• Trustee?
• Committee?
• Company?
Do trustees act unanimously or by vote?
• Stand-alone plan with separate stock bonus plan, with or without 401(k) features, or a DB plan • More than one ESOP sponsored by same employer
• ESOP combined with a profit sharing plan
What is a KSOP
• One plan with a 401(k) feature: Can include elective deferrals, employer matching/nonelective contributions, in addition to ESOP contribution
• Single plan document?
What is a KSOP… Cont’d
One TPA doing administration?
One audit
One Form 5500
KSOP: One or Two Plans
• Plan design provisions will vary if company is publicly traded or non-publicly traded
•
Private companies: Matching contributions in employer stock not subject to diversification
• Public companies: Must comply with PPA diversification rules
KSOP: One or Two Plans… Cont’d
• Generally can't use prototype plan for 401(k) when combined with ESOP
• Costly plan document? • ESOP admin generally takes longer than 401(k) plans
KSOP: One or Two Plans… Cont’d
Requires two different fiduciary provisions for investments in plan
• ESOP accounts: Trustee makes investment decisions - pooled account
• 401(k) accounts: Participant directed - segregated accounts
• Online account values
• Investment options
• Apathy towards stock
S CORPS and 409(p) Anti-Abuse Rule
• Concentration test applicable to S corps ensure broadbased stock ownership in ESOP • Layered, complex test
Have TPA/lawyer do a preliminary analysis
• Census data in drafting plan
• Family aggregation
• Will the ESOP buy back the stock from terminated participants and reshuffle shares
• Will company redeem the shares - resulting in reverse dilution
• Rules differ from other plans for timing, form and duration • Often designed based on company liquidity
• Be conservative, amend later
• Delay payment of shares purchased with Exempt Loan • Design evolves as value fluctuates • Design evolves as plan liquidity fluctuates
• ESOP has distribution exception from anti cutback rules
• Code says "modify"; regulations lay out availability and amendment restrictions
• Who has the power to "amend"?
• Does any fiduciary dare flex the power to "modify"?
• Distribution policies vs plan document provisions
• IRS attitude towards "policies"
Other Design Considerations
• "Reshuffling" and "Rebalancing" now permitted
• No longer discretionary availability
Periodically amend vs plan liquidity based
Other Design Considerations… Cont’d
• Timing of accounting, and at what value?
What about right to elect stock distribution and coordination with statutory diversification?
• IRS or DOL (or both) will look at it many years later • Be conservative first, generous later
Robert (Bob) Scarlata
Sr. Managing Director
Cell: 615-512-3555
Bscarlata@WhiteHorse-Partners.com
Jordan Bergkamp
Partner
Direct: 816-983-8269
Jordan.Bergkamp@HuschBlackwell.com
1. Scan the session QR Code on the door or directional signage nearby
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4. Complete the CE Survey.
Business is going well, and you are not ready to retire. The thought of exiting your business is a long way away.
So, why now?
We will cover:
I. Reasons to Sell Before an Exit
II. Whether to Consider a Full Sale or a Partial Sale
III. Potential Tax Savings and Other Benefits to ESOPs
IV. Questions From the Audience
What portion of your personal net worth is represented by your business ownership interest? If you are like most business owners, an overwhelming percentage is in your company.
ESOPs allow owners to take some chips off the table and diversify into other investments .
It does not need to mean loss of control – partial sales allow owners to diversify yet still maintain full control of the company.
ESOPs allow owners to protect themselves and their families when things don’t go to plan, such as death or disability.
None of us are guaranteed tomorrow.
Better to plan your exit today versus a day in the future when you are forced to. Particularly when pay-outs can take many years.
ESOPs are not only great for the owners but also for employees.
- Provides a significant retirement benefit at zero cost to them
- An ‘ownership’ culture where employees are more motivated
- Consistently voted ‘best places to work’
- Incentive to build a strong middle management team to run the company without the owner
With 75 million Boomers expected to retire by 2030, how can your business attract and retain employees in the current economic environment? -> ESOPs provide a way to create that competitive advantage.
Greg is a 45-year-old engineer who is making $75k per year. His company has been sold to an ESOP for $12 million. What does the sale mean to him?
Let’s assume:
• He works at the company until retirement (age 65)
• Both the company value and Greg’s salary increase at 3% per year
• His salary accounts for 12.5% of total company compensation
After working for 20 years, Greg’s ESOP shares could be worth: $910,000
This is in addition to his 401k value; plus, any savings he has made from his annual salary.
Research has shown ESOPs perform better versus comparable nonESOPs:
• Increased productivity - Output per employee increases 4% – 5% on average
• Faster growth - Job growth rates 25% higher over a 10-year period
• Increased performance - Sales growth +3.8% & employment growth +3.4% relative to pre-ESOP
• Less turnover - Employee layoffs 1/4 that of non-ESOP companies
ESOPs can be viewed as a friendly alternative to selling your company to a third-party.
With the right advisor team, ESOP sales can be significantly lower stress for the owner and can result in a faster and easier transaction versus a private sale.
Up to fair market value is paid for your company, by law.
Perhaps the greatest aspect of ESOP transactions are their flexibility.
There is no defined amount – 30%, 50% or 100% - you choose how much of the company to sell to an ESOP.
ESOPs allow ultimate flexibility as to how much of the company is sold and when. The business owner(s) can remain in control.
Pros:
- Partial sale can leave you in control of the business if needed for strategic reasons.
- Excellent option for family businesses or those with shared ownership, where just one shareholder needs or wants to retire.
-
No minimum percentage needs to be sold to an ESOP (a min. of 30% is required for a 1042 rollover). Can be increased over time.
Cons: - Minority stakes may be valued lower because they are less attractive to buyers (and therefore valuation firms).
- Administration costs are mostly the same whether a full or partial sale.
- Partial ESOPs may have fewer annual ESOP contribution expenses to offset costs.
- Section 409(p) testing can be challenging.
- The ESOP is also entitled to its pro-rata share of any distributions. If the “S” Corp makes distributions to the owner for taxes, the ESOP must also receive a distribution, which may be more than the company wants to contribute.
- “S” corporation distributions paid on ESOP shares are not tax deductible.
Pros: - Likely a higher fair market valuation per share versus a partial sale - an ESOP would be willing to pay more on a per share basis for a controlling block of stock as opposed to a minority interest.
- Smarter financial decision from an ongoing administrative cost perspective.
Cons: - Seller loses legal control of the company. However, selling business owners can stay in a leadership role post-sale.
- 1042 is a tax deferral, not a tax saving.
Sellers of “C” corps can elect to take advantage of Section 1042 and rollover 100% of share value into Qualified Replacement Property (QRP). This allows owners to defer capital gains taxes on transaction proceeds.
This means ZERO taxes at closing.
Companies must be a “C” corp. to take advantage of 1042. The seller must sell at least 30% to the ESOP. The seller must purchase the QRP within a period that is 3 months before and 12 months following the transaction.
Companies can take advantage of ESOP law to structure ESOP ownership so there are zero Federal or State taxes on operations, by setting up as an “S” corp.
This means that to the extent the ESOP owns the company, the cash flow that would otherwise be used to pay taxes becomes available to make acquisition debt service and fund growth opportunities:
• Increased cash flow for the company
• Bank and seller notes can be partially or fully paid with tax free earnings
Bill is the owner of ABC Manufacturing in California. He is fit and healthy and looks forward to retirement soon. He is considering his exit options.
• Est. company value: $18.3MM
By selling to an ESOP vs. a private buyer, Bill can increase his takeaway by an incredible $7.9MM, even for the same selling price.
*Required transaction value to result in a comparable Net to Owner as an ESOP sale.
By selling to an ESOP, Bill has deferred $5.74MM in taxes that he otherwise would not receive. This holds incredible value for him and his family as an investment*:
* Assuming an 8.5% market growth rate.
No founder or owner created their company alone. What better gift from you to those who helped you turn it into what it is today?
ESOPs – “Do Well And Do Good” at the same time.
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At the end of the session, you will be able to:
• Understand some of the major economic changes from a year ago
• Recognize how some of these economic changes may impact ESOP valuation
• Anticipate some of the diligence questions necessitated by the economic changes
ESOP shares must be valued at least annually, as of the plan year-end, in connection with the ongoing administration of the ESOP
• Historical Financials
• Projections
• Built from ground up or top down?
• More factors than typical to be discussed
• Supply Chain, Labor, Inflation for example
• Volume vs. Pricing
• 20 Year Treasury 1.94% on 12/30/21 to 4.41% on 12/30/22
• Equity & Microcap Premium 8.71% to 9.02%
• Total Cost of Equity up about 2.5% •
• Prime Rate 3.25% to 7.50%
• Moody’s Baa Corp Bond Yield 3.37% to 5.87%
• Stock Market
• Down about 20% in 2022
• Transactions (Data per GF Data)
• Q4 Deal Volume Down over 50% 2021 to 2022
• Volume lowest in 5 years
• Q4 EBITDA Multiples down about 10% (7.5x to 6.8x)
• DCF analysis incorporates economic, industry, & company-specific factors
• Forecast impacted by changing conditions
• Significantly increased cost of capital
• Cost of Equity and Cost of Debt both up.
• Combined roughly 20% value impact year over year.
• Uses the past results to estimate the future
• Given the changes in economic conditions, does that past reasonably represent future expectations?
• Guideline Public Company Method
• Market down about 20%
• Impact of performance, growth, margins, returns, and risk on Multiples
• Forward multiples versus historical multiples
• Guideline Transaction Method
• Impact of comparable timing
• Prior Transaction Method
• Still relevant?
• SARs
• Phantom Stock
• Warrants
• Offers to buy/sell
• Discount for Lack of Marketability
• Repurchase Obligations
• Other
Trustee and financial advisor should be able to reconcile the current valuation with past valuations and understand the differences.
Factors that impact changes in value:
• Company performance & expectations
• External factors (industry & economy)
• Company balance sheet (e.g., debt & cash levels)
• Valuation multiples in the industry
• Stock market and state of the M&A market
Greg is Managing Director of Value Management Inc. and has been actively engaged in the appraisal profession since 1989. He functions as a project manager responsible for financial analysis, economic analysis, and valuation of closely-held enterprises, asset-holding entities, intangible assets and publicly-traded securities. Greg has also prepared fair value analyses for financial reporting purposes, and served as an adviser in the purchase and sale of business enterprises. His appraisals have been used for financial reporting purposes, estate planning, ESOPs, mergers and acquisitions, marital dissolutions, recapitalizations, dissenting stockholders' actions, estate and gift tax, and fairness opinions.
Greg Kniesel Managing Director Value Management, Inc.
gek@valuemanagement.com
770-262-7259
Greg is an Accredited Senior Appraiser (Business Valuation) of the American Society of Appraisers and has served on The ESOP Association's Valuation Advisory Committee for over 15 years. He has taught business valuation courses and continuing legal education classes. Greg has spoken at numerous professional conferences and seminars on various business valuation topics, including ESOPs and mergers and acquisitions, and has provided expert testimony regarding business valuation issues.
Greg has authored various articles in Valuation Strategies, The Journal of Employee Ownership Law and Finance, and Journal of Taxation.
Rob is a Managing Director of South Park Advisors, an independent business valuation firm that caters to business owners, attorneys, accountants, ESOP Trustees, commercial bankers, trust departments, insurance agents, and financial planners. He has more than 20 years of experience providing valuation services to both private and public companies ranging in size from less than $1 million to $1 billion in sales.
These services have been used in connection with employee stock ownership plans (ESOPs), business succession planning, estate & gift tax reporting, mediation, equity sales, buy/sell agreements, recapitalizations, stock option plans, charitable foundation reporting, and lending purposes. Rob also focuses on the valuation of covenant-not-to-compete and non-solicitation agreements.
Rob Hilton, ASA Managing Director South Park Advisors, LLC
Rob is Executive Vice President of the New York/New Jersey Chapter of the ESOP Association. Rob is a regular speaker at national and regional ESOP conferences. He also frequently speaks on exit planning in general at various local, regional, and national events.
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In life, it’s not the hand you’re dealt, it’s how you play it.
What are the odds that tonight’s lead story on the news is positive?
(This is my iPhone screenshot)
• 2003 – MySpace
• 2004 – Facebook
• 2005 – YouTube
• 2006 – Twitter
• 2007 – Tumbler
• 2010 – Instagram & Pinterest
• 2011 – Snapchat
• 2016 - TikTok
“If you are not paying for it, you’re not the customer; you’re the product being sold.”
The words you use create the world you live in
• Pathway to Flourishing
• To be seen
• To be heard
• To make a contribution
• To be seen
• To be heard
• To make a contribution
• To be recognized
• Pair up with someone you don’t know well
• Create a High-Quality Connection
• First moments matter to set a trajectory of relating
• Questions and inquiries are essential resources for connection
• Common ground can be discovered relatively quickly
• Let your bodies talk!
• Non-verbal communication speaks volumes.
• Enhanced Cooperation
• Greater attachment of employees, customers and suppliers
• Increased adaptability
• Repeat business and lower cost of goods sold
• Broader thinking
• Builds resilience
• Enhanced self-image
• Increased cooperation
• Job satisfaction
• Greater organizational citizenship
Playing
• Participating in a game with another where the goal is to have fun
Respectful engagement
• Engaging the other in a way that sends a message of value and worth
Task enabling
• Helping another person’s successful performance
Trusting
• Conveying to other person that we believe they will meet our expectations and are dependable
• Create more respect
• Foster more trust
• Increase helping
• Design play/fun
• More Respect
– Know names before class
– Use names during class
– Improve pronunciation of names
• More Help
– Hold more office hours
– Provide individual feedback
– Give cell phone number
• More Trust
– Display vulnerability early through story
– Give others the benefit of the doubt
• More Play
– Participate in class exercises.
–
Playful breaks
• More Respect
– Talk with each new employee in 1st week
– Timely performance reviews with a development plan
• More Helping
– Ask for help
– Create coaching mindset
– Solicit feedback to make my ideas better
• More Trust
– Display vulnerability in training sessions
– Share why I care so much
• More Play/Fun
– Ensure gamification is being used
– Celebrate work anniversaries
• What’s a Routine:
– Repeated, recognizable ways of doing activities in organizations.
– Examples
• Hiring
• Training
• Meeting
• Rewarding
• Evaluating
• Impacts beginnings or first moments when an individual joins a community. First moments matter!
• Often core to values such as teamwork, care and respect.
• Often central to building teams.
• Building HQC through welcoming
• Ask yourself four questions?
–
How do I foster more respect?
– How do I create more helping?
– How do I make it more fun/play?
–
How do I encourage more trusting?
• Assign “Buddy”/Mentor
• Give small project that they can accomplish
Tom Bagwell
• Give employee cell phone number
• Tell them you trust them
• Explain how important their job is to you, the company and the customers
Tom Bagwell• Pick a routine
–
Hiring
–
Welcoming
–
Meetings
–
Training
– Breaks
• Ask 4 questions, what can I do to generate:
–
More Respect
–
More Trust
–
More Helping
–
More Fun/Play
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• What is the issue of the have and have nots?
• How does it happen?
• What is the concern?
• Provide tools and strategies available to avoid/remedy the issue
• Some employees (typically longer term) accumulate significant stock balances, while newcomers have much smaller balances
• Very few shares available for allocation each year
• Newer employees may receive very few shares each year
• One group is highly motivated to protect and enhance account value
• They view employee ownership as something truly significant
• Other group has meager account balances and are unlikely to see any benefit in the ESOP
• They may view the ownership culture with disinterest and cynicism
• Employee ownership message may stop working • Could result in accelerated repurchase liability concerns
• Fast repayment results in fast accumulations for those around during loan repayment period
• Very few shares available for employees hired after loan has been paid off
• Slow turnover
• Under utilized diversification feature
• Reduction in benefit levels after loan repayment
• Lengthy deferral of benefit distributions
• Acquisitions
• All shares are already allocated so this large block of new employees are left out
• Longer loan repayment schedule
• Recycling shares
• Contribute additional/new shares
• Buy an additional block of shares
• Releverage - redeem shares and obtain new loan
Expanded and/or mandatory diversification • Creative allocation formula
Rebalancing
Reshuffling
Declare victory and sell the company!
• Internal loan can be longer than outside bank loan
• Share release is based on this internal loan
• Determine loan amortization schedule by calculating a “normal” level of benefits over time
• Loan terms can be “stretched” so a large number of veteran ESOP participants will be leaving company when loan is paid off
• An exchange of cash for shares so the participant receiving a distribution can be paid in the form of cash
• Three options when an employee terminates
• Company redeems shares and retires shares
• Company redeems shares and recontributes
• Shares remain in ESOP and are recycled to existing participants with cash balances
• Distribution policy impacts number of shares available from terminated participants for recycling
• May potentially be largest source of shares for allocation to the have not participants
• Re-contribute shares that were redeemed from terminated participants each year
• Contribute shares from treasury stock
• Issue new shares to contribute
• May cause some share price dilution
• Typically used judiciously due to share dilution
• Only if ESOP is not already 100% owner
• Non-ESOP shareholders must be prepared to sell to the ESOP
• Great potential source of new shares, but not always a viable option
• Redeem shares and obtain new loan for these shares (which will be held in suspense)
• Loan is repaid with regular annual ESOP contributions
• Release of shares is spread over term of the loan
• “Layering” several loans over many years could result in a significant block of shares in the suspense account
• May be a good option if a large number of shares become available in a given year
• Retirement of a participant with a large account balance
• Special distribution/diversification windows
• Diversification option must be available for participants at least age 55 with 10 years of participation
• This may be accelerated or extended
• Offer diversification at an earlier age (age 50 for example)
• Require fewer years of participation in order to diversify
• Increase amount available each year (such as 50%)
• Extend past the normal 6-year diversification window
• Goal is to generate more shares available for recycling, releveraging , or redemption/contributions
• Participants don’t often elect when company stock out-performs market
• Takes decision out of participant hands
• May be limited design options due to non-discrimination rules
• Examples
• Diversification participants don’t share in recycling of shares
• All diversification eligible participants are required to transfer eligible amount to 401(k) plan
• Forced distribution at normal retirement age, including active participants
• Majority of ESOPs provide that contributions are allocated on eligible wages – this doesn’t need to be the case
• The only requirement is that the allocation formula doesn’t discriminate against non-highly compensated employees (have nots are typically not highly compensated employees)
• Use a points allocation formula
• Could be based on hours worked
• Award extra points in the early years of participation (i.e. 5 bonus points in first year, 4 in year 2, 3 in year 3, etc.)
• Would require additional compliance testing
• Reallocate the cash account and the share account so all participants have the same proportion of cash/shares as the trust holds
• Example: Trust holds 25% cash and 75% stock
• Frank has $1,500 in cash and $8,500 in shares ($10,000 total account value)
• Adjust his account so he now has $2,500 in cash (25%) and $7,500 (75%) in shares
• Transfer $1,000 worth of shares for $1,000 in cash
• Must have cash in the plan to be an option
• Must be outlined in plan document or distribution policy
• Communication to participants may be difficult
• Will be more complicated if ESOP has accounts not all participants are eligible to receive (i.e. 1042 shares)
For illustrative purposes only
For illustrative purposes only
• Transfer former participants out of participant stock and into cash
• Must have cash in the plan
• Must be outlined in plan document or distribution policy
• Vested balance vs. total balance?
• Cash flow requirement is similar to offering immediate distributions
• Payout is still able to be delayed (to prevent “taking the money and running”)
• Participants have accumulated quite large account balances
• Unsure how repurchase obligations will be met due to such large account balances -- and it seems insurmountable
• Purpose of the ESOP was to generate wealth through stock ownership, which was accomplished
• Declare victory and put up a “for sale” sign!
The presenter 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 presenter at the time this presentation was written, and this information is subject to change. The presenter makes 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 presenter does 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.
2770917-032023
Nancy Wiefek, Ph.D. Research Director
Aaron Supple Research Project Manager
1. Scan the session QR Code on the door or directional signage nearby
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4. Complete the CE Survey.
Be the prime source of comprehensive, user-friendly data on employee ownership
Provide benchmark data on best practices to help EO companies make data-driven decisions
Document the benefits of EO for individuals, companies, and communities
1. How many ESOPs are in my specific industry code?
2. How much do other ESOPs pay their c-suite executives?
3. What type of trustees do other ESOPs have?
4. How can I better show my employees the benefits of working for an ESOP?
5. What kinds of ESOPs are in my state?
6. How do ESOPs benefit my local community?
ESOPs hold more than $1.6 trillion in total plan assets
ESOPs paid out over $149 billion in benefits in the most recent year
Approximately 254 ESOP companies are set up each year
Professional/Sci./Tech. Services
Manufacturing
Construction
Finance/Insurance/Real Estate
Wholesale trade
Retail trade
Administrative support
Health care and social assistance
Transportation
Holding companies
Agriculture/mining/utilities
Other services
Information
Accommodation and food services
Educational services
Arts, entertainment and recreation
Privately-held ESOPs (n=5,380)
Privately-held ESOPs (n=5,380)
1. Many ESOPs are not advertising their employee ownership at all.
2. There is much room to grow in terms of ESOP companies communicating the benefits to their employees, clients, and customers of their being an employee owned company.
3. Far fewer are highlighting that their company is 100% owned by the employees.
• Executive compensation
• Corporate governance
• Handling the repurchase obligation
• ESOP benefit levels
• ESOP transactions
• Topics surveys
Uses: Learn from peers, 3rd-party compensation data, best practices, messaging…
• Over 250 respondent ESOP companies
• Wide range of company sizes and industries
• Data collected in Jan-March 2023
• Full results are available now. Our thanks to our respondents!
Base, incentive, stock-based, deferred, and total compensation percentiles for 8 executive positions
• Demographic information for comparisons, including:
• Size (revenue and employee count)
• Industry
S vs. C corporation
Questions about equity granting methods, ESOP benefit level, and more
In addition to executive compensation, this year we asked questions focusing on the labor market
Part-time workers
Earning less than $13.00/hour
Earning less than $16.00/hour
Source: U.S. Bureau of Labor Statistics, 2022
National Compensation Survey: Employee Benefits in the United States
Participation Access
Median ESOP account balance v. Median 401k balance
$80,500
*Source: U.S. Census Bureau, 2021 Survey of Income and Program Participation
Median ESOP Account balance (Not including 401k balance)
$30,000
Median 401k balance among working age individuals*
172 ESOPs in privately held companies
Headquartered
143+ across local communities
49,746
Covering over participants, with 39,322 current employees
1,132
ESOPs in privately held companies
Headquartered
781+ across local communities
323,204
Covering over participants, with 238,375 current employees
•
What kind of questions do you get about ESOPs?
•
What kind of data/bullet points/etc. would help you most in your daily business lives?
Nancy Wiefek, Ph.D.
Jamie M. Waldren, CFP® Managing Director Wells Fargo Advisors
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.
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
In your opinion, what is the most important factor that contributes to effective teamwork?
a. Clear communication and collaboration
b. Trust and mutual respect
c. Defined roles and responsibilities
d. Shared goals and values
e. all the above
What is the biggest obstacle to good leadership and teamwork in an organization?
a. Lack of trust and communication
b. Micromanagement and poor delegation
c. Resistance to change and innovation
d. Lack of diversity and inclusion
e. all the above
Author Unknown
1. Motivate – everyone on the team has to be inspired to move forward
2. Engage – an engaged team has the right people in the right roles has ready access to the resources they need to excel and is committed to fully showing up –every single day
3. Execute – it’s not uncommon for teams to get stuck in a constant state of strategic stumbling.
The value you and your team deliver to your customers
Consider these questions:
1. In your industry how common do you think it is for companies to disappoint?
2. How common do you think it for companies deliver on their promise, but go no further
3. How common do you think it is for companies to delight their clients – to add value beyond what I expected
4. How common do you think it is companies to defend their clients – act as advocates who not only delight their clients, but who protect them.
The ESOP dream team solutions has been carefully bult around nine strategies. Fully executed they will enable you team to rapidly ascend to world class performance
Strategy 1: Make everyone a winner
Strategy 2: Build a team of advocates
Strategy 3: Maximize our competence
Strategy 4: Have the right people on the buss
Strategy 5: Create your foundation
Strategy 6: Show up, commit, and contribute
Strategy 7: Create quiet confidence
Strategy 8: Stay on track
Strategy 9: Communicate for maximum impact
It’s true helping others achieve their goal works is a win-win.
• Unparalleled performance certainty (or "unmatched performance certainty") refers to a level of confidence and predictability in achieving specific goals or objectives. It means that the team or organization is able to consistently and reliably achieve high levels of performance and deliver outcomes that meet or exceed expectations.
• Unparalleled performance certainty is typically associated with high-performing teams or organizations that have a clear understanding of their goals and objectives, strong leadership, effective communication, a culture of accountability and trust, and a focus on continuous improvement.
• It is about having the right processes, systems, and tools in place to achieve desired outcomes, with a clear understanding of the expected results, and the resources needed. It is also about having the capability of managing risk and uncertainty, allowing for proactivity rather than reaction.
• Unparalleled performance certainty requires an organization to have a strong culture, engaged and motivated employees, efficient systems, and a clear process of continuous improvement.
• It implies that the organization is able to make reliable predictions about future performance and to deliver on its commitments to stakeholders.
• It's also important to note that, while unparalleled performance certainty is desirable, it can be difficult to achieve, as it can be influenced by external factors that are beyond an organization's control such as market conditions or competition.
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.
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.
11-in-10:
Eleven key issues you'll likely face in the first ten years of your ESOP and how to create a framework to address each issue
Where is your company in the ESOP journey?
A. Considering ESOP
B. We have an ESOP but it holds less than 50% of the company
C. We are 100% ESOP and still in the first six years of being an ESOP
D. We are 100% ESOP and are seven years or more into our ESOP journey
rises sharply
Why It’s Important
• Repurchase obligation (“RO”) is a company liability that will need to be funded with company cash flow
• RO will be minimal in ESOP’s early life but will grow (potentially significantly)
• RO growth will be driven by share growth and share allocation
Framework to Respond
• RO studies to understand potential future obligations
• Future cash flow & value analysis
• Sinking fund
Issue #2: Younger people in your organization will not embrace employee ownership with the same enthusiasm as the 45+ age group.
Why It’s Important
Employee ownership is a wonderful advantage for ESOP employees.
Employees embrace ESOP in varying ways. People who have an occasional thought about retirement embrace it.
Younger people don’t think about retirement, and they often find ESOP to be distant and not particularly meaningful. Like age, cultural issues can impact level of embrace.
• An ESOP is a defined contribution retirement plan but positioning it as such to employees will not resonate with a large portion.
Instead consider messaging:
• The meaningfulness of “ownership”
• The “free money” aspect of ESOP
• Wealth accumulation via ownership
How would you best characterize your employee’s attitude toward the ESOP?
A. Happy to have an ESOP but it’s not a huge deal at the company
B. Older people tend to love it, younger people don’t care all that much
C. Management level people love it, worker level people tend to be more indifferent to ESOP
D. ESOP is a big part of the company’s culture and identity
Issue #3: You will be faced with bringing on at external board members.
Most closely held businesses do not have an active Board of Directors, or at least no independent board members. Governance structures necessary for closely held businesses are different than those important in ESOP companies.
• The new board member is a resource to management
• Typically results in more discipline, which are best practices
• Adding a board member with ESOP experience is a consideration
Issue
Succession issues will emerge requiring planning, emotional considerations, difficult conversations and building a pipeline.
Sometime in the first ten years, usually earlier, the founder, leader and/or senior team members will be in a position to retire. This will be among the most challenging issues facing the company. It is usually emotional and often disruptive. Replacement candidates will need to be groomed or hired. Conversations will need to be had.
• Transition of the founder is almost always difficult. Elements that help include:
• Advance planning & a process
• The existence of a strong senior leadership team
• An engaged Board
• Internal replacement candidates
• Recognize that CEO succession planning often fails.
• Respect the emotional nature of exiting
Issue #5: Your company will end up "overinvested" in retirement benefits (which are not spendable in the short term) relative to pay and other benefits.
Why It’s Important Pay and benefits matter to employees and yet the ability to provide those is not unlimited. Companies with ESOP’s spend significantly more on retirement benefits than non-ESOP companies. Many employees will prefer “a little cash now” over “a lot of cash later.”
Why It’s Important Some tactics you can use include:
• Elimination of 401(k)
• Early diversification options
• Messaging about the compounding impact of ESOP
• The “overinvestment” is inevitable, but it isn’t a bad thing. Strong ESOP messaging helps.
Issue #6: You will need to think differently about corporate governance and stakeholders than you did previously.
Why It’s Important Corporate governance is the framework to govern the relationships among shareholder, director and officers. Each players role should be defined to support the overall progress of the company. Value of ownership and Control are separated in an ESOP company.
• The role of the Board is to provide guidance strategy, accountability for the CEO.
• Trustee is the shareholder acting in the best interest of the participants
• Officers ( management ) – Led by the CEO executes the strategic objectives of the company.
• Employee – owners share in the value creation
be multiple capital allocation decisions
Why It’s Important
• Repaying debt will be the primary focus immediately post-transaction
• After transaction debt, there will be various capital allocation decisions including:
• Warrants
• Capital investments
• Acquisitions
• RO
Framework to Respond
• Prepare strategy
• Timing
• How does one decision impact the other(s)?
• ESOP considerations
• Future value
• Determine whether balance sheet cash or 3rd party debt will be used
Why it’s important Managing employee expectations early and in the later years is critical to the benefits of the ESOP. Educating participants is the “why” is not easy as most employees don’t have a finance background. All these concepts come back to “What does it mean to be an owner?” Also there is a difference in value and valuation.
Framework to respond
• Use your professionals to assist in this process
• Correlate the value creation to a concept we all understand, ie. Home and mortgages
• Explaining the concept of debt pay down versus the multiple; enterprise value versus equity value.
• Risk vs. Reward
Issue #8: The rate of change of share price will likely slow as ESOP debt gets paid down. Communicating that narrative will be important and that takes some planning.
Which best describes your company with respect to leadership incentive plans?
A. We provide executives with incentive compensation plans, but these plans are not directly aligned with stock value
B. We have a framework in place for a stock-based incentive structure for executives, but we have not yet implemented it fully
C. We have a stock-based incentive structure for executives, but the jury is still out on how impactful it is as an incentive and retention tool
D. We have a stock-based incentive plan for executives and we think it is an effective incentive and retention tool
Issue #9: Synthetic equity plans being used to attract, retain, and incentivize key employees
Why It’s Important
• Common for new ESOP formations to include a comp plan tied to equity value growth
• Retain and incentivize key employees to execute on company initiatives
• Grow earnings, grow value, repay debt
• Aligns key individuals with ESOP
• Tool to help attract new talent
Framework to Respond
• Identify individuals for plan
• Current
• Future
• Succession considerations
• One-time grant or annual grants as part of compensation plan
• Compensation studies to assist in targeting awards relative to title
Issue #10: Despite being “employee owned", a material portion of your stock will likely be held by non-employees by year ten.
Your ESOP distribution policy likely leads to former employees having ESOP accounts. By year 10 those accounts can easily become as much as 20% of the ESOP shares allocated. In a growing company that’s both a source of capital and in many ways antithetical to the concept of employee ownership. This can be similar to a “have-have not” problem.
Options in the playbook include:
• Do nothing as undistributed/unsegregated accounts are a source of capital
• Modify distribution policies such that you guide the percentage ownership by non-employees to an acceptable level
• Explore ways to redeem nonemployee accounts
Issue #11: You will make a decision about how much to rely on “employee ownership” in branding your company to employees, prospective employees and your customer market.
Why It’s Important
Knowing what ownership means to your company provides the focus for these communications. More companies are using the “employee owned” externally to educate their community and finding loyalty in their customer base.
Framework to Respond
• Set expectations for your employees as to “ownership” and make it part of your language
• The ESOP is a recruiting and retention tool, so explaining to prospective employees how it differentiates you and give you an advantage
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.
After completing this session, participants will be able to…
► Understand the roles and responsibilities of Trustees in determining stock value
► Understand the basic concepts that need to be addressed in scoping a valuation engagement
► Recognize the methods typically utilized to value a business or ownership interest and understand their basic application
► Identify normalizing adjustments and assess their impact on value
► Reconcile values derived from multiple valuation approaches
• Roles and Responsibilities of Trustees
• Valuation Basics
• Standard of Value, Premise of Value, Type of Value, Level of Value
• Valuation Date, Purpose of Engagement
• Valuation Approaches
• Income Approach
• Market Approach
• Asset Approach
• Control and Marketability Considerations
• ESOP Trustee is the legal shareholder of the shares held in an ESOP Trust
• Trustee holds a fiduciary responsibility for the ESOP and its participants
• With regards to valuation the Trustee is:
• Responsible for the annual valuation of the ESOP shares
• Required to vet and retain an independent valuation expert
• Play an active role in the valuation process
• Establish the annual ESOP stock price, but does not perform the valuation
• Bears the responsibility of the valuation conclusion
• Is liable for any claims of undervalue or overvalue stock that are brought against the ESOP
• In a Transaction:
• The ESOP trustee selects the valuation professional advising the trustee in the purchase of shares
• Relies on the valuation professional to advise the trustee on deal terms
• Engages the valuation professional to perform a fairness opinion
• Fairness opinions, separate from a valuation opinion, is an opinion as to whether the transaction, as a whole, is fair and reasonable from a financial point of view, including price and financial dealings.
• Applies a reasonableness to all financial deal terms
• Gives the trustee protection and gives evidence of the fiduciary standard of care
• Fairness opinions access if deal values are falling within a fair market value range
• Fairness opinions are not deal recommendations: simply provide trustees with insight as to the objectivity of deal terms.
“There is no such thing as an absolute value in this world. You can only estimate what a thing is worth to you.”
Charles Dudley Warner 1829-1900, American Writer
Standard of Value
• Fair Market Value
• Fair Value
• Investment or Strategic Value
• In the context of ESOPs, valuation for the purposes of an ESOP transaction or ESOP annual update is always fair market value
• Employee stock ownership plans are qualified retirement plans governed by the Employee Retirement Income Security Act (ERISA). ERISA requires employee stock ownership plans to pay no more than “adequate consideration,” or fair market value, as reasonably determined by a trustee of an employee stock ownership trust, when investing in employer securities. The United States Department of Labor defines fair market value as:
• “the price at which an asset would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell and both parties are able, as well as willing, to trade and are well informed about the asset and the market for such asset.”
• Employee stock ownership plans are qualified retirement plans governed by the Employee Retirement Income Security Act (ERISA). ERISA requires employee stock ownership plans to pay no more than “adequate consideration,” or fair market value, as reasonably determined by a trustee of an employee stock ownership trust, when investing in employer securities. The United States Department of Labor defines fair market value as:
• “the price at which an asset would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell and both parties are able, as well as willing, to trade and are well informed about the asset and the market for such asset.”
• Market Value of Invested Capital = Debt Value + Equity Value + Cash
• Enterprise Value = Equity Value + Debt Value - Cash
• Equity Value = Enterprise Value – Debt Value + Cash
Cash
Enterprise Value
Debt Value
Market Value of Invested Capital
Equity Value
• The value of your home is like an enterprise value
• Enterprise Value = Equity Value + Debt Value - Cash
• Equity Value = Enterprise Value – Debt Value + Cash
Furnishings
Debt Value
House Value
Equity Value
Total Value of Home and
Furnishings
• Controlling / Noncontrolling (Minority)
• A control level value for a company represents an interest with effective control of the business.
• Marketable / Nonmarketable
• A marketable level of value represents an interest that holds high liquidity.
Source: Mercer Capital, the Level of Value: Why Estate Planners Need to Understand This Critical Element of a Buy Sell Agreement
Levels of Value
Controlling, Marketable
Controlling, Nonmarketable
Noncontrolling, Marketable
Noncontrolling, Nonmarketable
• A valuation is performed as of a defined date
• Only facts and circumstances known and knowable as of the Valuation Date are considered.
• A valuation is performed for a multitude of reasons
• ESOP
• Tax and Gift
• Management Planning or Advisement on sale
• Allocation of Purchase Price (Financial Reporting)
• Marital Dissolution
• Disputes
• The Fair Market Value of a 10,000 shares of common equity, which represents a 10% equity interest in ABC Company, Inc. as of December 31, 2022 on a noncontrolling, nonmarketable basis is $2,000,000, or $200.00 per share.
• Standard of Value = Fair Market Value
• Premise of Value = Going Concern
• Type of Value = Equity Interest
• Valuation Date = December 31, 2022
• Level of Value = Noncontrolling, Nonmarketable
• Valuation Methodologies
• Discounted cash flow method
• Capitalization of cash flow method
• Capitalization of earnings / Discounted future earnings
• Basic Steps
• Determine benefit stream and make normalizing adjustments as appropriate
• Determine cash flow adjustments
• Determine discount/capitalization rate
• Discount / capitalize cash flows
• Sum the present value of the cash flows
• Pros • Provides most “company-specific” value
• Can appropriately incorporate projected growth of the business
• Cons
• Most involved of the valuation analyses
• May be disagreements over likelihood of meeting projections
EBITDA
Less: Depreciation
Income From Operations
Less: Income Taxes
Debt-Free Net Income
Plus: Depreciation
Less: Capital Expenditures
Plus / Less: Change in Working Capital
Debt-Free Net Cash Flow
EBITDA = Earnings before interest, taxes, depreciation and amortization
• Adjustments for the discretionary expenses of the Business
• Owners’ compensation and Family member compensation
• Travel and Entertainment
• Rent (related party expenses)
• Separation of Assets/liabilities not necessary for the operations of the Business
• Non-operating assets
• Personal loans
• Unused real estate
• Adjustment of historical statements to be more representative of future performance
• Non-recurring or non-operating expenses, such as litigation fees or person expenses
• Extraordinary Items that do not occur in a “normal” operating year
• The terms “discount rate”, “required rate of return” and “cost of capital” are all synonymous
• There is a negative relationship between risk and return, and there is a negative relationship between the discount rate and value.
• There are several ways to calculate the discount rate, but it involves a “cost of equity” and a “cost of debt” to calculate a “weighted average cost of capital” (WACC).
• The Discount rate reflects:
• Equity Risk (Cost of Equity)
• Debt Risk (Cost of Debt)
The discount rate accounts for:
• Systematic risk (un-diversifiable) – Market-specific risks
• Unsystematic risk (diversifiable) – Industry and Company-specific risks
• Valuation Methodologies
• Guideline Merger and Acquisition Method
• Guideline Public Company Method
• Basic Steps
• Determine benefit stream and make normalizing adjustments as appropriate
• Find comparable transactions/guideline public companies
• Calculate valuation multiples and apply to subject company
• Make adjustments as necessary to arrive at equity value (if necessary)
• Pros
• Incorporates market conditions and prices paid in recent relative transactions
• Objective source of data
• Easy to explain and apply
• Cons
• Comparability of Subject Company
• Stock market has emotional aspect to it
• Can be misleading if debt is not considered
• The M&A market involves many specific buyers and sellers who may pay a premium or discount
• The “value” accessed in the marketplace is viewed in a multiple of earnings
• Price / Equity
• Price / Earnings (20x-25x)
• Enterprise Value / Revenue (0.5x – 3x)
• Enterprise Value / EBITDA (3x – 20x)
In millions (USD), except per share
Average 2021:17.1x
Average 2022: 13.2x
Average of a 23% decline in EV/EBITDA multiples YoY
Energy the largest decline of 40%
Year
Communications Consumer Discretionary Consumer Staples
Energy Healthcare Industrials
IT Materials Real Estate Utilities
Utilities the lowest decline of 3%.
• Valuation Methodologies
• Adjusted Net Asset Method
• Basic Steps
• Adjust assets to fair market value
• Adjust liabilities to fair market value
• The asset approach is used as a determinant of value when:
• The net asset value of the Company is higher than the market approach or income approach
• no future cash flows available
• Asset intensive businesses
• Liquidation scenario
• Valuing specific assets
• Pros
• Provides “floor” value
• Simple analysis
• Cons
• Use of assumptions in liquidation scenario
• Not indicative of FMV for healthy operating companies
• May need to obtain appraisals on real estate or fixed assets
• Control Discounts are handled in two ways:
• Level of Cash flows discounted (controlling cash flows or noncontrolling cash flow)
• Applying a control discount
• Control adjustments are supported through a number of studies and models, including the Mergerstat Review Control Premium Studies, and other qualitative analysis on control factors, such as voting power, ability to appoint officers, and make major decisions of behalf of the Company
• Magnitude of control discounts applied in any valuation analysis is heavily dependent on the facts and circumstances of the engagement
• Marketability Discounts are handled by:
• Applying an adjustment for lack of marketability.
• Marketability adjustments are supported through a number of studies and models, including the restricted stock studies, pre-IPO studies, option-based models and qualitative analysis on marketability, such as the ability to transfer or sell stock
• Magnitude of marketability discounts applied in any valuation analysis is heavily dependent on the facts and circumstances of the engagement
• Understand the roles and responsibilities of Trustees in determining stock value
• Understand the basic concepts that need to be addressed in scoping a valuation engagement
• Recognize the methods typically utilized to value a business or ownership interest and understand their basic application
• Identify normalizing adjustments and assess their impact on value
• Reconcile values derived from multiple valuation approaches
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.
Recruiting?
Onboarding?
Learning and development?
Engagement?
Retention?
Remote/virtual interview experience
• Prioritize human connection, help them be at ease
• Insights into Hypertherm, no layoffs in over 50 years
• Introduce Associate Ownership: daily experience, longterm financial benefit and outlook
• Share insight into our culture, what it is like to work here
• Recovery Friendly Workplace
• Culture focused site visits
• 40 hours of paid volunteer time per year
• Goal of being carbon neutral by 2030
• STEM programs have produced 14 new hires
Prioritize the candidate experience, pacing.
Focus on the candidate experience: the time between accepting a job offer and starting on day 1 can be the most fragile. Build connection early.
Define Day-1: The day they sign their offer, or their first official at work?
Prioritize experience, pacing. Candidate experience and day 1: Welcome morning onsite in NH with Microsoft Teams for remote new hires in hybrid sessions
• Start with ownership culture-Working at an ESOP will be a different experience
• Overview of learning and development resources, safety, HR, complete key tasks
• Lunch with New Hire Buddy and leader, afternoon with team
• Make it easy to ask questions, get answers, remove, “Who do I go to for what?”
• If you build more HR self-service, they will use it
Give them time. You can’t tell culture.
Focus on learning needs of current and future workforce
• Modular and upskilling approach to curriculum
• Focus on key job skills and technology instead of theoretical
• Apprenticeships, job shadows, mentoring, coaching
• Paid accredited technical education: Technical Training Institute
• Continuous improvement in action: 3D printers
• Reach into the elementary, middle and high schools: STEM
• Leadership development by levels, certifications
• Leader meetings with learning focus, roundtables
“Our organization.” Own it.
• Share survey results with organization, not just management
• Teambuilding and global community - Create avenues to learn each other’s history and what they bring to work
• Participatory decision-making forums: Problem Busters, listening sessions, focus groups
• Don’t assume people know each other or know everyone’s name
• Welcome new hires while also recognizing and appreciating tenure
• Strength Finder, focus on strengths
• Work in multiple languages
Communication elevated: they know what is going on, and why
• Connections points: check-ins, support resources
• Support learning and development, tuition reimbursement
• Flexible work arrangements where possible
• Cross-training
• Continuous improvement culture and training: Black Belts
• Apprenticeships, job shadows, mentorships, redeploys (aspirational, shortterm)
• Ownership culture and communications
• ESOP shares and profit-sharing programs
• “My voice matters.”
What is working at your ESOPs?
Connection points – meet 2 other attendees
What are 2 ideas from this session that you will try?
Come back together as a group
Share out additional ideas
Close Thank you
