Basic ESOP Distributions / Repurchase Liability


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Sr. ESOP Administrator
Blue Ridge ESOP Associates Phone: (312) 651-6319
kkuster@blueridgeesop.com
www.blueridgeesop.com
Kip is a Sr. ESOP Administrator at Blue Ridge ESOP Associates focused primarily on ESOP administration, repurchase obligation studies, pre-transaction ERISA compliance testing, plan design, and From 5500 preparation. Kip is a member of the National Center for Employee Ownership, American Society of Pension Professionals and Actuaries (ASPPA), the ESOP Association, and an associate member of The ESOP Association’s Advisory Committee on Administration.
CEO & President
PenChecks Trust
Phone: (800) 541-3938
Spiro@penchecks.com
www.penchecks.com
Since joining PenChecks in 2002, Spiro has held several different positions including Director of Operations, Director of Sales & Marketing, and VP of Strategic Development. In his current role as President & CEO, Spiro’s primary focus is on growth, cultivating strategic partnerships and initiating the development of new products and services to keep the company at the forefront of the rapidly changing retirement plan industry. In more than 20 years with PenChecks, there's not much Spiro hasn't see when it comes to distributions and missing participants.
Sponsor Concerns
Distribution Policy
Payment Procedures
Best Practices for Missing Participants
A payment or disbursement of benefits from the ESOP. Can occur or be triggered for a variety of reasons. Sometimes confused with distributions of S-corp profits (“dividend”).
What the sponsor is liable for if participants exercise their put option. Can refer to a single year or a span of multiple years.
• Financial
- What is the impact on annual cash flow?
- Is the current policy sustainable over time?
• Administrative
- Is our policy easy to communicate and understand?
- How difficult is it to administer the policy?
• Cultural - Does it properly incentivize employee actions?
Governs the payment of ESOP distributions
- Adopted by the sponsor
-
Plan administrator executes the policy
- Trustee funds the distribution
Must follow IRS timing rules
- IRC § 409(o) Special Accelerated Rule for ESOPs
- IRC § 401(a)(14) General Rule for Qualified Plans
• Be administered in a uniform and nondiscriminatory manner
- Cannot favor certain participants over others in the same class
- Specifics are written in the plan document
- No discretion to the plan administrator
- Any changes to policy requires a plan amendment
- Provides discretion to the plan administrator
- Commonly written to statute
- Often accompanied by a written, internal policy document
Separation Diversification
• Death
• Age 55
Other In-Service
• Not required
• Permanent Disability
• 10 years of participation
• Retirement
• Any other voluntary or involuntary termination
• Qualified Election Period lasts for 6 years.
• Often seen triggered at Normal Retirement Age
• Year 1-5: 25%
• Year 6: 50%
• When does distribution commence?
Usually no more than 6 years after termination
• How many payments occur?
Typically, five annual payments (more for larger accounts)
• In what form is the payment made?
Cash or Employer securities
• Consent requirements
Can “force out” balances up to $5,000 ($7,000 beginning in 2024)
• Your policy can be more beneficial than statute requires.
§409(o) – ESOP Special
• Term’d as a result of “DDR”
No later than the year after termination.
• Non-DDR
No later than the 6th year after termination.
• 5-year Limited Dist. Period
• Financed Securities exception
May exclude employer securities purchased with exempt loan
§401(a)(14) - General
• No later than the 60th day after the close of the plan year in which:
‧ Earlier of age 65 or Normal Retirement
Age
‧ 10th anniversary of participation
‧ Termination of service
• Generally, the affirmative election of the participant is required, unless:
- Vested balances up to $5,000
- Participant is age 62 or Normal Retirement Age (later)
- Death benefit to estate or beneficiary
- Payment is a required minimum distribution (“RMD”)
• “Right to Defer” notice must be provided
- Within 180 days of first payment
- At least 30 days before first payment
• Rollover to another qualified plan
- Any distribution except a required minimum distribution (“RMD”)
- No income taxes are recognized
• Non-rollover payment directly to participant
- Taxable income recognized in the year of payment
- Mandatory 20% federal withholding applies at payment
- If before age 59½: additional 10% excise tax will apply (unless terminated after achieving age 55, death, or disability)
- If distributed in form of stock (redemption) & single lump sum: Net Unrealized Appreciation (“NUA”) treated as long term capital gains
• What is a Missing Participant?
Participant or beneficiary who can’t be located or does not respond to reasonable communication efforts
• What is an Uncashed Check?
Self explanatory; largely considered same as a missing participant in eyes of the government • Why Should You Care?
Fiduciaries must make reasonable efforts to locate MPs as part of duties of prudence and loyalty
Background
Why Else Should You Care?
Because missing participants affect plans
• Inability to pay plan benefits
• Failure to pay RMDs
• Failure to meet disclosure requirements
• Undelivered participant communications
• Uncashed checks
• Complicate plan terminations
Guidance
• Guidance was sparse for a long time
• Most guidance geared towards terminating DC plans
• 3 New guidance publications in 2021; focus on preventing missing participants
Google: “DOL Missing Participant Guidance”
- Missing Participants – Best Practices for Pension Plans
- Compliance Assistance Release 2021-01
- Field Assistance Bulletin 2021-01
• “Red Flags” may suggest a missing participant problem
- More than a small number of
‧ Missing/non-responsive participants
‧ Termed vested participants @ NRA
- Missing, inaccurate, or incomplete info
- Absence of sound P&Ps for returned mail
- Absence of sound P&Ps for uncashed checks
Four Main Practice Areas:
1. Maintain Accurate Census Information
2. Implement Effective Communication Strategies
3. Missing Participant Searches
4. Document Procedures and Actions
Contact parts periodically to confirm contact info
Include contact change info in all plan communications
Flag undeliverable mail for follow-up
Regularly request updated contact info for beneficiaries
Search for missing participants during M&As
Prompt participants to confirm contact info on online platforms
Use plain language & offer non-English
Prominently state up front what comm is about
Encourage contact through sponsor websites and numbers
Onboarding and offboarding P&Ps
Comm info about consolidating accounts
Use original plan sponsor name on communication
Check related plan records
Check with designated beneficiaries
Use free online search resources
Use commercial locator service
Use death searches if missing for a long time
Register on public & private pension registries (NRURB)
Attempt contact via USPS-certified mail, email, phone, text, and social media
Reach out to colleagues
Reduce plan’s P&Ps to clear written instructions
Document key decisions and actions taken
Ensure third parties perform agreed-upon on services
‐ Work to correct shortcomings
• DOL BPs are not binding and do not have force of law
- However, standard is out now
• Consider costs of particular search efforts given the circumstances
• Ensure procedures are designed to maintain contact with all participants
• Consider which BPs are likely to be effective and implement them as SOPs.
- Establish consistent process
- Have written documentation
- Follow it
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• Learn about the various roles and responsibilities of parties involved in ESOP-owned companies and their roles and responsibilities
• Develop an understanding as to the current trends in ESOP litigation impacting Board members
• Identify various ways to minimize risk associated with ESOP litigation
• Board of Directors
• Governing body of the company
• Acts on behalf of all shareholders
• Management Team
• Generally, the senior employees of the company
• Runs the day-to-day operations of the business
• ESOP Trustee
• Acts on behalf of the ESOP as shareholder
• ESOP Committee/Plan Administrator
• Responsible for ESOP administration and reporting
• Gives direction to directed Trustee
• Every corporation is owned by SHAREHOLDERS
• Shareholders elect the BOARD OF DIRECTORS
• The Board of Directors evaluates MANAGEMENT
• MANAGEMENT (Chief Executive Officer) handles the dayto-day operations of the Company and manages the EMPLOYEES
• What about the ESOP?
• The ESOP is a shareholder and shareholder rights are generally exercised by the ESOP TRUSTEE
• Approves the company’s strategic direction proposed by management
• Elects, oversees and advises management
• Evaluates significant corporate transactions
• Establishes and maintains corporate governance practices
• Establishes and oversees executive compensation programs
• Appoints, monitors and/or removes the ESOP Trustee (unless delegated)
• Can allocate or delegate duties to individuals or committees
• Power determined by allocation or delegation document(s) or charter
• Common Board Committees:
• Audit: approves budgets and projections, financial statements and audits
• Compensation: determines compensation of board and management; oversees executive compensation and retirement plans
• Governance/Nominating: oversees regulatory compliance, Board and management; nominates new directors
• Special: can be formed for specific purpose
• Should operate and make most decisions at regularly scheduled meetings
• Generally, should hold at least quarterly meetings
• Special meetings may be called at special intervals
• Committee meetings should also take place, but do not have to be at same intervals or same time
• Subject to state law, can be via phone or video conference
Answer Differs By Company
• Requirements:
• Understand and be committed to governance process
• Ability to think strategically
• Interest and time to commit to process
• Considerations
• Balance
• Dynamics
• Specific Skills and education
• Personal Style
• Size - Usually between 3 and 9 people
• Experience - Consider familiarity with company vs. new perspectives
• Competencies - Good mix of skills support variety of goals and functions
• Diversity - Different background brings different viewpoints
• ESOP Experience - Challenges facing ESOP companies are different from other companies
• Inside vs. Outside Director - Whether director has a previous relationship with the company
• Typically, executives currently employed by the Company, though often times the CFO is NOT on the Board
• Important to separate role of employee from role as director
• Review candidates to be sure that they meet the Board of Directors’ criteria:
• Should not be afraid to speak up
• Should have significant business skills
• Should be nimble enough to react to changing business situations
• May not be aware of market-wide risk factors
• May not be able to challenge management as well as an outsider
• May not be able to be as impartial as an outsider
• Increased potential for conflicts
• Lack of Outside Voice/Expertise
• May not been viewed as having credibility
• Not necessarily independent; just someone who is not an employee of the Company
• May be required by ESOP Trustee as part of initial formation transaction
• Brings outside experience based on their previous business background
• Should review conflicts before accepting appointment
• Likely will expect compensation for serving in role
• May bring market-wide risk factors to attention of Board
• More likely to be able to challenge management
• Greater impartiality
• With proper vetting, less likely to have conflicts
• May be perceived as having additional credibility
• Applicable State Law
• Company’s Articles of Incorporation
• Company’s Bylaws • Other Corporate Governance Policies and Procedures
ESOP Trustee Requirements
ERISA
• Corporate Fiduciary Standards
• Duty of Care
•
Duty of Loyalty
• Reviewed under the Business Judgment Rule
• Courts do not second guess the Board’s business decisions when such decisions are made:
• In good faith
• With the care that an ordinarily prudent person in a like position would exercise under similar circumstances
• In a manner that is reasonably believed to be in the best interests of the company
• Investigation and Deliberation
• Informed Decision Making
• Must be informed of “all material information reasonably available” before acting
• Monitor Corporate Operations and Compliance
• Must receive enough information to understand results of operations, variations from budget, business trends, etc.
• Review Management and confirm whether:
• Proper risk management assessment has been completed and proper risk management policies have been adopted
• Adequate internal controls for financial and legal obligations have been adopted
• Independence and Transparency
• Conflicts of Interest
• Usurpation of Business Opportunity
• Competition with Company
Disclose, Disclose, Disclose
• There are no separate specific statutory requirements for ESOP Company Boards BUT:
• ESOP Boards must appoint, monitor and, if necessary, remove the ESOP Trustee (ERISA fiduciary obligations)
• ESOP Boards should read and understand the annual valuation report
• ESOP Boards must understand how the laws applicable to ESOPs and how benefits are provided to ESOP participants
• ESOP Boards must more carefully scrutinize potential conflicts of interest
• ESOP Boards should take a more active role than that of a private company Board
• When serving as an ERISA fiduciary, the Board MUST ACT:
• Solely in the interest of plan participants and beneficiaries;
• For the exclusive purpose of providing benefits to participants and their beneficiaries;
• Defray reasonable expenses of administering the ESOP;
• With the care, skill, prudence and diligence under the circumstances then prevailing that a prudent person acting with like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;
• In accordance with ERISA and the ESOP Plan document
• What happens if you are a Director and an ERISA Fiduciary?
• Must comply with both sets of legal duties
• Must keep separate when acting in one role or the other
• i.e., think about what “hat” is being worn when making a decision
• Separate when making fiduciary and non-fiduciary decisions
• Consider having separate meetings to make such decisions
Breach of corporate fiduciary duty
• Failure to act prudently/exercise care
• Failing to assess corporate risk in a timely manner
• Declare dividends or distributions that affect the Company as a going concern
• Failure to be loyal to the Company
• Personally benefiting at the expense of the Company
• Approving a contract that disproportionately benefits the Director
• Failure to monitor appointees (such as ESOP Trustee)
• Halperin v. Richards (7th Cir. 2021)
• No ERISA preemption of state law fiduciary duty claims against “two hat” directors
• Indemnification
• Sources of indemnification
• DOL’s position on indemnification of ESOP fiduciaries
• Vet Board advisors, trustee candidates, trustee advisors, and Plan service providers
• Fiduciary training
• Documentation of key decisions and understanding of privilege
• Review of insurance
• Review of indemnity obligations
• Process, process, process
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I. Understand the role of different advisors supporting a company throughout an ESOP transaction
II. Learn when it is advisable to include an investment banker in the process of establishing an ESOP transaction
III. Identify the pros and cons and value proposition with respect to various processes and fees in establishing an ESOP transaction
I. Definition and Roles of “Advisors”
II. “Traditional” ESOP
III. “Current” Transaction Considerations
IV. Case Studies with examples of:
I. When to use an investment banker
II. When you don’t need to use an investment banker
III. Sense of what the right team of advisors is when
V. Costs
a) ERISA Attorney
b) Plan Administration
c) ESOP Trustee
• For a transaction
Learning Objective 1
Understand the role of different advisors supporting a company throughout an ESOP transaction
• Ongoing
d) Valuation
• Company
• Trustee
e) Lender
f) Investment Banker
• Feasibility
• Modeling
• Iterations
• Quarterback
• Negotiations
• Project Management
Learning Objective 2: When do you need an investment banker?
The complexity of needs in the transaction drives the allocation of the roles among the advisors
Each transaction is different; set fees accordingly
Project Manager
1. Project manager works with selling shareholder on feasibility and design of ESOP transaction
• ESOP Plan Administration
• ERISA Lawyer
• Lender
2. Project manager assists company and selling shareholder to interview and select a transaction trustee
a) Suitability & feasibility
g) Valuation
b) Transaction structure
h) Synthetic Equity
c) Financing
d) ERISA and IRC compliance
i) Professional Service
Businesses
e) Project Management
j) Number of Selling Shareholders
f) Ancillary Legal and Tax Issues
• Corporate / commercial
k) Wealth Advisory
• Executive Compensation
l) Regulatory requirements
• S-Corp, C-Corp
m) Fairness
a) Examples where No Investment Banker is Required:
• Kevin to provide examples
b) Examples where an Investment Banker is Very helpful:
• Mary to provide examples
Learning Objective 2 & 3: When do you need an investment banker?
Identify the pros and cons and value proposition with respect to various processes and fees
a) Not “going to market” to consider non- ESOP alternatives
b) Not seeking complex financing beyond standard senior bank financing
c) Traditional advisors can well meet company and shareholder needs
d) Simpler straightforward transaction
• Minority ESOP
• Number and psychology of selling shareholders
• Size and industry
• Earnings “story”
e) Pricing is cost prohibitive
1) Company corporate and ESOP counsel costs are highly variable depending on existing agreements, firms used, and amount of legal work required by the transaction
2) The wide range is a function of the caliber of company counsel and any unique issues that arise
3) Based on current relationships and final structure
1) Company corporate and ESOP counsel costs are highly variable depending on existing agreements, firms used, and amount of legal work required by the transaction
2) The wide range is a function of the caliber of company counsel and any unique issues that arise
3) Based on current relationships and final structure
I. ESOPs were generally:
1. Alternative to strategic or going public
a) Private equity had not developed as an Asset Class
b) Sometimes viewed as “buyer of last resort”
2. Prevailing tax benefits:
a) 1042 – deferral of capital gains to seller
b) Bank ability to shelter some interest income revenue
c) Lower cost of financing
d) Corporate tax deduction equal to the ESOP contribution
3. Partial C-Corp Transactions
a) Only C-Corporations were eligible ESOP shareholders
a) Today this segment is often referred to as “business banking”
b) Syndicated loan markets were an exception
c) Legacy partnership and professional services were an exception
6. Staged Transactions
7. General industries
a) Industrial
b) Construction
c) Retail
d) Less business and professional service companies as a subset of the economy
The simplicity of the size, industry, and general ownership of these companies, made knowledgeable and experienced professional teams highly effective for ESOP implementation
Rise of Private Equity as an asset class
a) ESOP’s are a financial buyer similar to private equity
b) Financial buyers are a competitive transaction alternative
2. Legal modification allowing S-Corporations to be a valid ESOP shareholder
a) Counts as a single shareholder
b) ESOP exempt from federal income tax
c) Legal clarification in the anti-abuse provisions in June 2001
d) Steady increase in popularity of S-Corporation ESOPs
e) Feasibility analysis often evaluates practicality of zero – 100% ESOPs
f) Relative decline in 1042 transactions
a) Offshoring manufacturing contributed to the shift
b) Professional service firms generally do not have access to a key tax benefits (depreciation) commonly used by industrial companies to shelter income taxes
a) Private equity and corporate divestitures join private business owners, evaluating ESOPs as an exit strategy
a) Successful C-Corporation ESOPs making an S election
b) Service companies (engineering, consulting, advisory, etc.) transitioning from partnership models to S-Corp ESOP models
7. Rise in Non-bank Financing Alternatives
a) Uni-tranch
b) Private placement
c) Direct lending
d) Structured equity
e) Private equity
f) Social Impact funds
g) ESG (run by John to see if he would add anything)
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• Continued Impacts of Covid-19
• Consequences of Silicon Valley Bank
• Labor Shortages and Supply Chain Woes
• Inflation Concerns
• Industry Stressors
• Duty of Care
• Directors and officers must inform themselves of “all material information reasonably available to them” prior to making a business decision
• Directors and officers must “act in an informed and deliberate manner”
• Duty of Loyalty
• Directors and officers have an “affirmative duty to protect the interests of the company, but also an obligation to refrain from conduct which would injure the company and its stakeholders or deprive them of profit or advantage”
• Directors and officers must “eschew any conflict between duty and self-interest.”
• Encompasses duty of good faith, which requires that directors and officers act with intent to further stakeholder interests and in what they believe to be the best interests of the company
• To the extent that directors and officers are also equity holders, they should be careful to distinguish between actions taken on behalf of and in the interests of equity holders and actions taken on behalf of and in the interests of the company
• The directors and officers of a company owe their fiduciary duties to the company, for the benefit of its stakeholders - which stakeholders may obtain standing to bring a claim for breach of fiduciary duty depends on whether the company is solvent or insolvent
• Solvent Company - Only stakeholders may obtain standing
• Insolvent Company - Both stakeholders and creditors may obtain standing
• Directors and officers have a duty to maximize the value of the company for all residual claimants
• Creditors are first in line
• Stakeholders are the residual beneficiaries of anything beyond what is necessary to satisfy the claims of creditors
• Because the moment of insolvency can be difficult to determine, directors and officers of a should seek to serve both stakeholders
• Directors and officers of a parent company whose wholly-owned subsidiary is insolvent owe a fiduciary duty to such subsidiary and, derivatively, to its creditors
• Best practice is to make decisions rationally designed to increase the value of the company as a whole
• Courts use three tests to determine whether a company is insolvent
• Equity Test (i.e., the cash flow insolvency test)
• A company is insolvent if it is unable to pay its debts as they become due
• Balance Sheet Test
• A company is insolvent if the sum of its debts exceeds the “fair saleable” value (which is not “fair market” value) of its assets
• The balance sheet test is not based on GAAP, but instead looks to the fair saleable value of assets and stated value of liabilities
• Adequate Capital Test
• A company is insolvent if it does not have adequate capital to operate the business
• Directors may need expert opinions on whether the company is solvent
• The advice of advisors may be evidence considered by a court if the insolvency determination of the directors is later challenged
• Conduct quality board meetings (e.g., agendas, preparation and distribution of materials, robust discussion, timing of meetings)
• Closely review all material information prior to making decisions and involve counsel in drafting meeting minutes to ensure clear documentation of the deliberation process
• Hire advisors to investigate specific issues, educate board members, and present their analysis
• Independently evaluate assumptions and information presented by advisors
• Do not merely be passive recipients of advice; ask questions of advisors until satisfied as to all issues
• Make decisions as if directors owe fiduciary duties to both creditors and stakeholders.
• Seek to preserve/enhance the maximum value of the corporate enterprise
• Build a thorough record of actions that fully reflects that the Board met its duties of care and loyalty to all constituencies
• Permit all decisions related to “insiders” (i.e., conflicted officers/directors) to be made by independent and disinterested directors
• Establish committees (e.g., audit, executive, finance, transaction-specific).
• Review organizational documents (e.g., budget, strategic plan, operations overview)
• Refrain from engaging in overly risky strategies that may only serve to benefit certain stakeholders
• Do not give preference to one stakeholder or class of stakeholders over another
• Be honest and disclose all material relevant facts, including any situations that may compromise independence
• The duties of the ESOP Trustee do not change based on the insolvency of the company
• The duties of the ESOP Trustee remain solely to its stakeholders – the ESOP participants and beneficiaries BUT
• Where the ESOP is the majority stakeholder or the sole stakeholder of the company, the ESOP Trustee’s oversight of the Board, where the company could be considered insolvent, should be with a view to the shifting duties of the Board, i.e., duties now owed to stakeholders and creditors
• Duty to maximize the value of the company for all residual claimants
• Creditors are first in line as the residual beneficiaries of any increase in the value of the company
• Stakeholders are the residual beneficiaries of any potential increase in the value of the company beyond what is necessary to satisfy the claims of creditors
• The makeup of a Board may afford protection to the Board generally
• Maintaining a minimum number of independent directors ensures that the Board will be able to effectively and fairly evaluate decisions related to insiders
• The business judgment rule is the default standard under which courts will consider whether directors and officers have fulfilled their fiduciary duties
• Under this rule, courts will not second-guess a decision by directors who were disinterested and independent, acted in good faith, and had a reasonable, informed basis for believing the action authorized was lawful and in furtherance of the company’s purpose
• Courts look to a Board’s decision-making process rather than substituting their own judgment for that of the board or otherwise proving the objective reasonableness of a decision
• Assess the company’s liquidity situation
• What liquidity does the company have
• What liquidity does the company need
• Note any upcoming maturities and the business’ ability to satisfy those obligations
• Evaluate covenant terms to determine whether there are existing or impending defaults
• Assess the impact of any default and applicable cure periods
• Consider the implications of missed targets on the ability to achieve longer term projections and revise business plans accordingly
• Assess the implications of mandatory expense reductions, the delay of capital expenditures, etc. and the ability to obtain subsequent financing
• Evaluate the supply chain and other key components of operations, such as vendors, contract parties, and customers
• Consider whether these parties need support to ultimately protect the business
• Maintain connections with customers, as their habits, needs, and preferences change
• Assess the duration of contracts, renewal rights, termination rights and requirements, and force majeure provisions and consider whether contracts should be extended or canceled
• Consider the specific provisions of the contract and the ability to replace the contract
• Develop communication strategy
• It is important to reassure employees in order to avoid a negative impact on the workforce and retention
• Consider employee retention or incentive plans for key employees
• The ongoing employment of key employees during a restructuring process is critical, as they will be most familiar with the business and best positioned to help make important decisions
• This is particularly challenging for an ESOP because of concerns regarding stakeholder value
• It may be necessary to approach lenders (3rd party and related), either because of an impending covenant default or to seek other relief
• Forbearance can extend runway for determining longer term solution
• When approaching lenders
• Be prepared, organized, and ready to share financial and operational information
• Present a plan for the business that demonstrates the outcome of the relief to the lenders and its impact on the borrower’s ability to repay lenders
• Ask for what the business realistically needs (plus some cushion), as it will be more difficult to approach lenders again in the future
• Lenders will want to confirm
• The stability of the business
• The feasibility of the business plan
• That the lender is properly protected
• Has the benefit of working with parties with preexisting relationships
• Already know the business
• Already have money at risk they will want to protect
• Could be challenging if relationship is already strained
• Not likely to provide additional liquidity
• May not provide all that is needed to address the challenges
• Considerations for capital raises include
• Limitations on issuing new equity (S. Corp.)
• Tax issues with issuing new equity (S. Corp.)
• Differences from private-equity backed companies;
• Smaller universe of potential investors
• Inability to use convertible debt (S. Corp.)
• May be able to obtain sub debt or structured equity
• Determine if the S. Corp tax savings still matter
• Defer/forbear or forgive payments due under Seller Debt
• Write down or exchange portion of Seller Debt in return for equity or synthetic equity
• Provides flexibility to the company by freeing up cash flow and offers the Seller appropriate return for reducing the amount owed
• Often friendly investor who already knows the business
• Seller protection from fraudulent conveyance challenge
• Conversion may vitiate some or all of S Corp ESOP tax benefit
• Issuance of equity (including synthetic) has to be weighed against the viability of the company (and value of the ESOP) if the debt was not exchanged for equity
• ESOP will want to see that all other sources of capital (that do not require equity issuance) have been exhausted
• The exchange of seller debt for company equity may constitute a prohibited transaction if conducted at less than fair market value or in the absence of absolute and relative fairness to the ESOP
• Further, regardless of cause or basis in fact, if the company’s insolvency is within the statute of limitations (6 years) of the ESOP’s equity purchase, careful consideration must be given to potential ERISA fiduciary breach claims alleging that the ESOP overpaid originally
• Will impact 409(p) testing if company is operating as an S Corporation
• Increase in synthetic equity
• Potential decrease in ESOP stakeholders if layoffs have occurred
The Board must receive a fairness opinion on the restructuring of Corporate Debt?
• The Bankruptcy Code allows fraudulent conveyances to be voided if there is actual or constructive fraud
• Fraudulent conveyances require
• A transfer of the debtor’s property or interest in property
• A two-year look-back period
• An actual fraudulent conveyance also requires that the debtor transferred assets (or incurred obligations) to a third party with an actual intent to hinder, delay, or defraud any creditor or future creditors of the debtor
• A constructive fraudulent conveyance also requires that
• The debtor received less than reasonably equivalent value
• The debtor was insolvent at the time of the transfer or was rendered insolvent as a result
• Depending on liquidity needs and specifics of the business, it may be able to sell a portion of the business to raise necessary liquidity
• Evaluate appropriateness of running a sale process and a potential sale transaction
• Consider impact on the ESOP
• Buyer unlikely to want to take ESOP or any portion thereof
• Sale of entity or assets and related workforce will result in termination of those individuals (partial termination of ESOP?) from ESOP participant and thus may acerbate cash flow issues through increased repurchase liability
• 409p Testing – decrease in overall stakeholders
• ESOP Loan Servicing – contribution limitations
• Even if the company is insolvent, the ESOP Trustee may demand a portion of the sales proceeds to not contest the sale in bankruptcy
• Careful assessment of the costs and benefits conferred upon the ESOP and the likely consequences of a failure to refinance on the company
• Refinancing may also benefit the employer (for example, by reducing the employer’s cost of providing future contributions on an annual basis), but ESOP Trustee must act with undivided loyalty to the participants and beneficiaries
• Inducements for the ESOP Trustee plan to engage in the refinancing
• shares held in suspense account not applied to repayment of the outstanding portion of the refinanced loan if the ESOP is terminated (often referred to as "event protection")
• additional diversification rights for participants
• an increase in the amount of the employer's matching contribution
• the payment of a "dividend make-whole" to compensate participants and beneficiaries for the increased use of dividends for loan repayment
• Whether the sponsoring employer has made an enforceable commitment to make contributions necessary to retire the loan is deciding factor in inducements the ESOP Trustee will require
It is not legally permissible to refinance an ESOP Loan?
• A chapter 7 bankruptcy is for liquidation
• A trustee is appointed and runs the process to liquidate and distribute assets to creditors
• No discharge is granted to non-individual debtors
• Involves lower costs than a chapter 11 bankruptcy
• A chapter 11 bankruptcy may be pursued for a liquidation or a reorganization
• Management and the Board of Directors continue to control and operate the business and properties in the ordinary course of business with judicial oversight
• A discharge of debts is granted to the debtor
• The process is generally more costly and lasts longer than a chapter 7
• Upon filing of chapter 11 petition, automatic stay immediately goes into effect
• The automatic stay provides a debtor with protection from adverse actions based on prepetition obligations
• Prevents new lawsuits from being filed against the debtor outside the bankruptcy court
• Stays continuation of all pending litigation
• Prevents even at-will termination of contracts by counterparties without court approval
• Creditors that take actions to violate the automatic stay may be subject to sanctions
• The automatic stay does not provide the debtor with absolute protection, as the stay may be lifted following a showing of cause
• A debtor typically funds its reorganization efforts through one of two mechanisms
• Obtaining “debtor-in-possession” (or “DIP”) financing
• Using cash on hand (“cash collateral”)
• Bankruptcy Court approval of either method of funding is usually sought as a “first -day order”
• DIP financing is often senior to all other debt
• Either the cash collateral or DIP financing order will contain certain conditions (usually negotiated with the DIP lenders or the lenders who hold a lien in the cash collateral) relating to
• Timing of the case
• Reporting/consent procedures for payments of a certain kind or size
• Procedures for reimbursement of lenders’ professional fees and expenses
• Provision of “adequate protection” (e.g., liens on unencumbered property, super priority administrative liens, etc.)
• A debtor faces numerous constituencies in chapter 11
• New constituencies may include
• The U.S. Trustee is an arm of the Department of Justice and is responsible for overseeing the administration of the bankruptcy cases
• The bankruptcy judge will not be involved in day-today operations of the company but will rule on transactions outside the ordinary course of business and the implementation of chapter 11 relief
• If appointed and necessary, the creditors’ committee will include a small number of the debtor’s biggest creditors and will represent the interest of the debtor’s creditors generally
• The chapter 11 process allows the debtors to bring all constituents—even those that would like to disrupt the process—into a single forum: the bankruptcy court
• It is important to understand at the beginning whether a business needs a financial or operational restructuring
• Financial restructuring focuses on addressing issues with the capital structure
• Operational restructuring focuses on business specific issues such as footprint and key contractual relationships
• This impacts the duration of the case and who the key parties will likely be
• Section 363 of the Bankruptcy Code governs the sale of assets by a debtor outside the ordinary course of business during chapter 7 and chapter 11 bankruptcy proceedings
• A “stalking horse bidder” may be appointed in advance of the auction with the execution of a binding purchase agreement for purchase of assets, subject to higher and better offers at auction
• Under section 363, a debtor has the right, with court approval, to sell assets free and clear of liens, claims, and other encumbrances
• Purchaser can acquire assets from a distressed company with cleaner title than in an out-of-court sale, supported by a bankruptcy court order authorizing the sale
• Debtor can maximize recovery for the estate and have certainty of closing a sale
• The Bankruptcy Code permits debtors to assume, assume and assign, or reject executory contracts and leases
• “Executory contracts” are contracts where performance is required by both sides of the agreement as of the petition date
• Damages of a rejected executory contract or lease treated as a prepetition unsecured claim
• Damages from rejected leases are capped by the Bankruptcy Code.
• Until the debtor determines whether to assume, assume and assign, or reject the agreements, the debtor and counterparty must continue to perform in the ordinary course of business
• A counterparty may not invoke clauses that provide for termination of the contract upon a filing of a chapter 11 case
• Such provisions are called “ipso facto provisions” and are generally unenforceable in bankruptcy
• Such provisions may be enforced when performance would be excused by operation of law, or the obligation is to make a loan or other financial accommodation
• A debtor may not assume or assume and assign “personal service contracts” without the counterparty’s consent
• A chapter 11 case typically culminates with the confirmation of the debtor’s plan of reorg
• The plan should be the result of negotiations among the debtor and key constituencies
• The plan sets forth the treatment of claims against and interests in the debtor’s estate
• The plan may provide for the release of certain claims by and against Board members, company personnel, and certain debtor and non-debtor parties
• These provisions can be a powerful bargaining chip and ease concerns among constituents about potential liabilities arising from the chapter 11 process
• Once approved by the bankruptcy court at a confirmation hearing, a plan binds all parties-ininterest that received proper notice, even if those parties voted to reject the plan
• The plan discharges prepetition claims, including litigation, against the debtor, except to the extent that the plan expressly preserves such claims
• To avoid ERISA fiduciary claims from hamstringing the post-reorganization business, it is imperative such contingent liabilities are not preserved in the court approved reorganization plan
• Generally, the ESOP and ESOP participants are treated as “equity holders” in bankruptcy, which makes them effectively last in line for getting paid for their stock in the Company that is being liquidated in bankruptcy
• Former ESOP participants in payment status have priority over active ESOP participants - In re Indian Jewelers Supply Co., the bankruptcy court held that several former employees of an ESOP-owned company were debt holders, and not equity holders, for bankruptcy purposes.
• Similarly in Merrimac, the bankruptcy court found that ESOP repurchase obligations were debt claims, rather than equity because of retirement and ERISA policy goals
• However, in spite of the nature of the ESOP’s status as only an equity holder, some banks and institutional lenders are uncomfortable lending to ESOP-owned companies, though research proves that ESOP-owned businesses are less likely to default and, if they do suffer a default, generate less losses for the lender
• Remedies for this concern include equity pledges from the ESOP/company (to prevent the ESOP from acting as the equity holder), proper review of the ESOP plan document to ensure proper protections (as allowed by ERISA) pertaining to benefit vesting and timing, etc.
Heather
StephensHuman Resources,
ManagerPraxis
Consulting GroupEmployee Engagement
Restek
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Diversity, Equity, Inclusion and Belonging
Culture
Leadership
Strategy
Mission Impact
Employee Engagement & Ownership
Customer and Client Satisfaction
Growth & Sustainability
“Diversity” determines who is in the room
“Inclusion” means everyone in the room is heard and feels valued
“Equity” ensures everyone in the room is given opportunities to grow and succeed
The overarching visible and invisible glue that holds groups of people, organizations, and nations together
The opposite of Othering is not “saming.”
Imagine you are talking to a someone about what it’s like to work at your organization.
What would you say?
What is the “inside story” about how things work?
In groups of 3 discuss your thoughts and the themes that emerge
Where is your Board?
Where is your executive management team?
Does your Board have a DEI Committee?
Does your Board have an employee ownership committee?
What does your board need to learn?
Founded in 1985
Humble beginnings in 1985, Restek starts out in a single room of an elementary school–turned business incubator making Fused Silica capillary columns
today – 140,000 ft2
Bellefonte, PA U.S.
The Restek Campus Restek Corporate HeadquartersResearch & Manufacturing:
Global Headquarters, Bellefonte, PA
Glastron, Vineland, NJ, U.S.
Microquartz, Munich, Germany
Sales Offices:
Global Headquarters, Bellefonte, PA
Restek Thames (London)
Restek France (Paris)
Restek GmbH (Frankfurt)
Restek Italy (Milan)
Restek Spain (Madrid)
Restek Japan (Tokyo)
Restek China (Beijing)
Focused on the Customer 100% ESOP in 2008
Focused on Employees
Plus 1 Service – free, fast, friendly service – go the extra mile
Innovation – improved workflow solutions for chromatography
Execution – quality products and services on-time
A safe, healthy and energetic working environment
Since every Restek employee is also an owner, every one of us has a vested interest in our success.
• First elective purchases 1998-2001
1998
• 2.1% employee owned
2001
• Pool of Restek shares available because of ESOP transactions
• Match of more than 3% of pay provided from 2001-2004 – grew to 9.5% employee owned
2004
• Began exploring how to move 100% ESOP ownership
• ESOP transaction provided a pool of shares to increase to 22.3%. Match increased to 6% of pay
2005
• From 2005-2008, Restek made contributions which released shares
• Match continued to be offered at 6% of pay
2008
• Leveraged 100% ESOP transaction made a pool of shares available for decades
• Match continued to be offered at 8% of pay or more
• Over the past 14 years, Restek stock value has grown exponentially by almost 1800%
2022
2020: Grass Roots Efforts & Focus Group Discussions about True North
2021: Introduced Employee Engagement as Strategic Focus
Q1 ‘22: Began conversations with Praxis about DEIB
July ‘22: Praxis delivered DEIB workshop with Leadership Team & Board of Directors
Sept ‘22: First ever global engagement survey; incorporated DEIB Questions & demographics
December ‘22- January ‘23: Partnered with Praxis to Conduct 8 focus groups
February ‘23: Presented long term multi-phased DEIB strategy to Board of Directors
Shared Purpose & Core Values
Long-Term Focus
Incentives to Work Together
Employee Engagement
Improved Communication
Creativity & Innovation
Transparency & Accountability
Better Retention
Our 2022 Global Engagement Survey provided in-depth data with breakdowns by manager, geography, and demographics
With our excellent participation (77%- 386 total employees), we also we gained over 2,759 comments across the company
~65 total employees volunteered for 8 different Focus Groups
Feedback also gathered by managers & supervisors from survey results sharing & action planning team meetings
We held 8 different demographic Groups in December & January proctored by Praxis consultants.
Anyone
LGBTQ+
Group size ranged from 6-10 employees and were offered as a hybrid event held onsite in our training rooms with cameras/screens for participants joining virtually.
Third Shift
Remote Employees
Supervisors & Managers
Topics discussed included the Leadership Team (executive), Direct Mgrs/Supervisors, Career Growth, Compensation, Diversity, Inclusion & Belonging.
Women
White Men
Restek is at a crossroads on its growth journey and employees across the organization are feeling the tension of:
Where we are going and what will need to change in the future
Clearly Defining & Communicating Our Vision
Organizational Learning, Education & Development
Setting Clear Expectations
Company Commitments
Assessment & Evaluation
• After much discussion, we recommended to our board that we keep the word ‘family’ because it is bolder
• We felt that it raised expectations for who we are and are striving to be.
• We discussed that it will be important to be specific as to Restek’s vision of why we aspire to be a family; making sure that it is tied back to our Core Values & employee ownership culture
RESTEK’S ‘NEW’ TRUE NORTH
Restek is a family of employee-owners committed to an inclusive, diverse, collaborative, and safe workplace dedicated to the success of our colleagues, customers, business partners and to supporting the local communities in which we operate.
• The term ‘community’ was about equal to ‘family’ as a preference in the revised True North statements, though some shared it could be a potentially negative association for some employees.
• Those who identified more strongly with the word family, did clarify that they felt that it was more in relation to their direct teams.
• The change from ‘employees’ to ‘employee-owners’ was well received.
Phase 1: Foundational (2023-2025)
• Introduce our Vision and set the stage for Restek’s commitment to DEIB, starting with a focus on Inclusion & Belonging
• Provide foundational learning on key inclusion & belonging themes by role
• Review current policies, processes, and systems; prioritize for action
• Introduce basic concepts of Diversity & Equity
• Establish baseline metrics & accountability
• Develop internal communications strategy to support efforts
Phase 2: Integration (2026-2028)
• Regular DEIB trainings and workshops for leaders & staff
• Deepening of Diversity and Equity knowledge & practices
• Robust strategy and internal communication plan in place
• Revisions & updates to existing policies, processes or systems identified in Foundational phase
• Measure impact & change
Phase 3: Sustainability (2028 & beyond)
• DEIB efforts evolve & continuously improve
• Culture remains stable, diverse, and inclusive even with turnover, new hires, etc.
• Restek is a model that others can learn from within the ESOP community as well as our industry
• Employee engagement, morale, and belonging is high
Foundational Knowledge & Skill Building Based on Role
Focus on what behaviors drive inclusion and create clear ties to our ownership
culture Leaders will be shown how to model these behaviors and equipped with knowledge to be successful in reinforcing
Real examples given to employees to help them understand how this will be applied and what their responsibilities are to one another
Mutual Trust & Respect- employees should resolve it with the other employee
Employee has a conversation with a manager or HR for support
Manager talks to the employee and coaches on behavior
Follow progressive discipline if needed
Partnership with key stakeholders across the business will help create buy-in and allow us to better influence change across the organization.
Policies, Processes, & Practices
Compensation & Benefits Talent Acquisition
Processes
Rewards & Recognition
Talent Development & Training
Opportunities
Promotions & Organizational Structure
Our Core Values and True North should guide our way on our DEIB Journey.
Engage employees across the globe in DEIB activities
Recognize that our DEIB work is a journey, and we are at the beginning.
Diversity, Equity, Inclusion and Belonging is important to all of us.
As Restek’s leaders, we will own it and be accountable to the overall success.
Defining success and developing metrics to measure progress will be critical
Restek’s DEIB efforts will be a perpetual work in progress, as we are committing to an ongoing journey in which we never reach a destination, but will be guided by:
Our Vision: True North
Multi-Year Strategy (starting with Inclusion & Belonging)
Leadership Team Commitment
Core Strategic Focuses:
o Ongoing Education
o Clear Expectations
o Company Commitments
o Continuous Assessment & Evaluation
Significant
Not
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4. Complete the CE Survey.
How would you announce that you are becoming an ESOP; and that your employees will benefit from the fantastic wealth building opportunities that equity presents?
It is not enough to tell people that you are trustworthy. You should have examples, and then build on them!
You Can Not Expect Your People to Be Honest if You Don’t Create a Culture That Promotes It
What does it mean to create a culture that promotes honesty?
If you are an officer, one of the most important things you can do is make your people feel heard and feel like they have a relationship with you.
The more available you are, the more comfortable your staff will be to share ideas.
You don’t have to say yes to all of them, some ideas will not make the cut.
When you have opportunities, do fun things that help your people know each other at a level beyond just surface-level work interactions.
Be transparent, it’s less to remember and people know when you are genuine. Get comfortable breaking the ice. It’s equally as important as that spreadsheet.
When we heard it takes 10 years to build a culture, we laughed, until we realized that we had a long way to go. Once we realized that we had people pulling against the rope, we made some difficult decisions after that.
Defining what you expect from your employees should be priority What do you value?
1. Humility
2. Honesty and trustworthiness
3. Great communication up and down the ladder
4. Commitment to lifelong learning
5. Think like an owner, because you are
Everybody loves semi-weekly emails from accountants about financial numbers, right?
•New people
• Future-looking company strategy
•Staff poll questions
•ESOP information
•Bonus Pool
•Hidden games
•Inspirational short stories that match your culture
•Funny memes, I should stress work appropriate
•Staff background interviews – assuming they want to share
•Interesting stories from history that have a resonating point
•Major wins
•Opportunity areas
•Oh yea, and the numbers, bonus points for bonus pools
• Meet with your teams
• Make it engaging
• Let them decide matters that will affect them most when you can
• Teach about ESOP and financial literacy, but stress what the benefit is to them.
• Leave time for questions
• Leave time to interface with them after the team meeting. Some questions people are afraid to ask
• Talk about plans for the future
• Talk about opportunity areas
• Let it be fun when it can be fun
• How many of think that your company would list communication as one of your top issues?
• How many of your companies have defined what expected communication looks like?
• How long do you spend on communication expectations in your interviews?
• To make your team better you have to communicate when they make a mistake or don’t live up to expectations. Failure to do so creates blind spots and stunts professional development.
• Obviously, there is a right way and a wrong way.
• Praise publicly, coach, and council privately.
• You should have a way to report positive feedback. wins@chillcoinc.com
• We host a C Level executive interview for every employee we hire.
• We tell every prospective hire that the expectation of both positive and negative feedback needs to flow up and down our organization.
• Bosses must put their egos aside to avoid blind spots and bad direction.
• Even if you tell them all, not everyone has the backbone to say something. Anonymous surveys are helpful as well.
• some disagreements between coworkers need to be elevated to management, but for common issues and problems, you should give guidance in the interview about how disagreements should be handled.
•Professionally discussing minor issues without elevation builds respect and better relationships.
•If your teams feel free and comfortable to communicate, you will be shocked at the ideas they share!
•Again, set your ego aside. Some ideas don’t be used, but feeling heard makes all the difference.
•Many will be used and be transformative. Successful ideas from line-level employee owners only encourage other great ideas! !
• This is why ESOPs are so great!
• Our bonus pool is companywide and based upon company success.
• Make sure long-term success is prioritized over quarterly success.
Ginny Vanderslice
• Cofounder of Praxis Consulting
• 30+ years working with ESOP companies
• Focus on Ownership Culture, Leadership Development & Succession
• Creator & Academic Director of Executive Leadership Program for ESOP CEOs at University of Pennsylvania; Sponsored by The ESOP Association
• Co-author of Leadership Development and Succession Planning article in a recent NCEO publication (available at the NCEO table)
Carolyn Stanworth
• President and CEO of BL Companies since 2010
• Primary driver responsible for planning and instituting the ESOP at BL Companies
• Champions the multi-year Leadership Development initiative and succession planning efforts
• Works with senior leaders, managers, and external consultants in the implementation and enhancement of the shared ownership culture at BL Companies
BL’s integration of LD and Succession
Principles of integrating these initiatives
Q&A
• New Perspectives
• Un-tried, no history
• Known entity
• Lack CEO experience
• Experience not available inside
• Values/ style risk
• Career path; professional growth
• Internal competition/ potential politics
• Generate excitement
• Culture risk; unaware of politics
• Continuity: know company, business, culture & stakeholders
• Challenge re peers
• Easier to make hard changes; not tied to history
• Fail more often
• Know any potential landmines
• Know about gaps; need development
Both are core to a strong Ownership Culture
• Employee owners want professional development opportunities
• Mitigates risk if someone leaves; increases leadership capacity overall Culture sustainability; Business continuity
• Know the value of the culture
• Have the skills to support the culture
Steadily increasing overall leadership capacity
Preparing for company growth
Lower Risk
Ongoing risk mitigation for all key positions
Competencies: Skills & Knowledge
Executive Planning Aligning
Leader
Manager
Supervisor
Engagement
Delegation
Accountability
Team building
Individual contributor
Listening Feedback Conflict
Power Dynamics
Decision Making
Coaching
Strategic Thinking
Systems View
Leading Change
Programs can be designed for & integrated across all levels
• Interconnected content, linked to culture
• Common language and foundational skills consistent with culture
• With increasing responsibility:
» Deeper self-understanding
» Increase skill complexity & mastery
» Broaden focus
» More difficult challenge assignments
Professional Services Firm
Architecture
Engineering
Environmental
Land Surveying
380+ Employees in 16 Offices in 11 States
• CT, NY, MD, PA, OH, MA, NC, NJ, RI, TX, FL
100% Employee Owned - ESOP in 2006
38 Years in Business
• Stronger team and leadership bench
• Wanted to change our culture
» More professional; more systematic
» Learning organization, more responsibility and accountability
• Competitive Advantage
» Attract and retain best talent
» Increase candidate pool for crucial roles
• Provide skills for all employee owners to be engaged in leadership
• Intentional about succession for long term sustainability
Leadership Development Essentials and Advanced Program provide skills that support the Succession process.
1. Strategic Thinking
2. Assessing Performance / Potential
3. Developing the Ideal Team
4. Leader as Coach
5. Culture
6. Feedback
7. Systems Thinking
Succession Planning is a core job responsibility
1. Identify Future Organization / Key Roles
2. Define Competencies and Strategies
3. Identify Candidates
4. Assess Candidates and Readiness
5. Develop Candidates
6. Monitor Progress
7. Repeat (create routine)
Key Roles
• Strategic Importance, Specific Role Responsibilities
• Strategy for Succession (e.g., internal, external, etc.)
• Candidates
Assess Candidates
• Leadership Competencies
• Current Functions
• Future Functions
40% of Employee Owners are participating in committees or teams that drive critical business decisions and processes.
Substantial multi-year investment in all Employee Owners for training and ongoing learning.
• Understand the value of your investment
• Start anywhere
• Build a consistent language
• Define additional skills/knowledge needed at each level
• Set clear expectations that all managers develop potential successors
• Integrate skills into all talent management processes
• CEO/President must actively champion
Ginny Vanderslice
Founding Principal Praxis Consulting Group
Ginny@praxiscg.com
Carolyn N. Stanworth
President and CEO
BL Companies
Carolyn@blcompanies.com
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• Acquisition topic is realistically unavoidable
• Key facet of strategic plan
• May have a Chief Growth Officer or directed executive role
• Company maintains a target acquisition list or is actively engaged with a buy-side broker
• Executive may be tasked with outbound solicitation of acquisition targets
• Expectation is periodic feedback and discussion with the Board
• But what about when the roles are reversed?
• Does the Board and Executive have a framework for discussing inbound solicitation interest?
•
“Would you be interested in selling?”
• “Is the Company for sale?”
• Who needs to know if inbound solicitation is received?
• May not be everyone depending on party and level of interest
• It’s important to discuss or have a framework of how to elevate the conversation
• Need to consider:
• Basis for decision making
• Wasting time
• Creating distraction
• Cost associated with diligence
• Reputational / Client Vendor Risk
• Legal / fiduciary duties of role
• Duty of Care (State Law)
• Informed, decisions based on material information available, critical assessment, engagement of advisors where necessary
• Duty of Loyalty (State Law)
• Act in good faith in the best interest of the corporation. Refrain from conduct that could injure the corporation or place personal interest higher, including self-dealing
• Duty of Prudence (State Law)
• Act with skill, care, prudence and diligence under the thenprevailing circumstances
• Board Composition
• Internal vs. External Board Members
• Doesn’t change required duties
• Can help mitigate real / perceived conflicts
• Protected by the “Business Judgment Rule”
• Applied by courts in analyzing directors’ actions
• In a breach of duty of care claim, director is insulated from liability for the consequences of a business judgment if director acted in good faith and with the best interests of the company in mind
• If the business judgment rule applies, courts will look at decision-making process, not the final decision
Only External Board members are required to follow the Duties of Care, Loyalty and Prudence.
Duty as an officer of the Company •
Duty as a Board Member (if applicable)
Obligations of as executive team member (non-officer)
Awareness of participation in industry peer groups and one-on-one meetings
• Circumstances Driving the Sale of an ESOP Company
• Unsolicited offer
• Non-ESOP majority shareholder
• Market conditions and industry dynamics
• Company-specific issues
• Types of Solicitations / Offers
• Inquiry • Indication of Interest
• Letter of Intent
• Definitive Agreement • Each type of solicitation / offer deserves a certain level of response
There is no black letter law as to what makes an offer bona fide, but it often has some, or all, of the following:
Proposed consideration is nominally adequate; Other proposed deal terms are fair and reasonable and treat all shareholders equitably;
Potential buyer has the financial ability to pay the proposed purchase price;
Potential buyer has a track record of completing transaction and has a valid strategic intent;
Potential buyer has completed sufficient diligence;
Potential buyer’s transaction team is knowledgeable and rebuttable; and
The closing of the proposed offer is based on conditions preceding and / or subject to requirements that are customary.
• What is the Board / Executives’ Plan for reviewing and responding?
• Practical tips for reviewing
• Fishing expeditions
• Confidentiality
• Sharing information
• When is there no requirement to respond?
• Does the Board have formal policy of how to respond?
• When is the Trustee notified?
The Company must inform the Trustee of all offers they receive from prospective buyers.
Considerations for Remaining Independent
• By-Laws & Articles of Incorporation
• B-Corporation
• State of Incorporation
• Following the Policy
• What are the requirements?
• Parameter for diligence and / or running a process?
• Do you share this with the Trustee?
• Can you suspend the policy?
• How restrictive can the policy be?
Who is responsible for evaluating an unsolicited offer?
• How has the Board satisfied its duties?
• Identify conflicts and address if present
• Follow Board policies (if any) on handling of unsolicited offers
• Avoid jumping to a conclusion / decision (acting in haste)
• How available options and information were considered and documentation for reasons and analysis
• Communication
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Radian Research became a 100% ESOP in 2008.
110 employees with 2 facilities: Lafayette, IN & Pearl, MS
We design and manufacture products to test the accuracy of electricity meters and we develop software products to manage electricity meter test data. Our main customers are electric utility companies around the world.
Janet Jones - Accounting
Meredith Peterson – Customer Support
Jamie Nolan - Engineering
Kim Chaney – Production
Elaine Wilson - Production
Pedro Ramirez - Marketing
Tom Eddleman - Engineering
Roquelle Fogarasi – Admin - Team Lead
Renée Mundell - Coach
• Concerning Issues regarding Annual Performance Reviews:
Too time consuming.
Too infrequent
Too manager driven. “Feels like going to the principal’s office.
• Objectives for new process:
Timely & Relevant
Safe to showcase talent and own mistakes
Empowering employees to own performance and growth
To create a safe, supportive Employee Owner evaluation process, wherein the Employee Owner experiences satisfaction in the demonstration of accountability, and with support of their manager implements self-initiated, continuous improvement output to enhance performance by shifting the emphasis from past performance to what does an Employee Owner need to contribute in a manner which exceeds expectations that delivers above and beyond.
Moving the performance evaluation to a regularly scheduled twoway discussion allowing for greater flexibility and responsiveness to the need of the Employee Owner and the business.
3 SAFE Check-Ins
April: Check-in 1
September: Check-in 2
February: Check-in 3
Purpose of the Self-Assessment for Employee Owners (SAFE) Check-Ins
1. Check-ins are a “safe place” to own mistakes, share thoughts and concerns.
2. Check-ins are to support Employee Owners in doing their best work.
3. Check-ins are to foster communication and feedback.
4. Check-ins are to improve Manager/Employee Owner relationship.
(A public document showcasing a team’s talent related to its productivity) The purpose of the Score Card is to provide transparent, objective performance information in relation to relevant goals. The Employee Owners, with manager guidance, of each Department/SubDepartment/Team will create a transparent, visible Score Card.
April: a. Employee Owner discusses with manager Score Card performance over four (4) months. Employee Owner provides:
i. what he/she is proud of regarding his/her contribution to RADIAN.
ii. what he/she wants to improve on this year.
iii. how can his/her manager help.
April:
b. Employee Owner reviews Key Responsibilities and outlines Objectives for the current year, which align with top level company Goals, manager approves, with revisions, as applicable.
i. Topics:
1. Review Objectives from the previous year.
2. Set Objectives for the current year.
3. Key Responsibilities.
September:
a. Employee Owner discusses with manager Score Card performance over four (4) months. Employee Owner provides:
i. what he/she is proud of regarding his/her contribution to RADIAN.
ii. what he/she wants to improve on this year.
iii. how can his/her manager help.
b. Career Check-in
SAFE Check-in 2 is a way to get to know the employee and what they do and do not enjoy doing.
1. Are you doing what you want to be doing?
2. Where do you want to go and how can I or RADIAN help you?
3. Are you happy as a RADIAN Employee Owner?
4. On a scale of 1 to 10 (1 being not likely and 10 highly likely), how likely are you to recommend RADIAN to a close friend?
February:
a. Employee Owner discusses with manager Score Card performance over four (4) months. Employee Owner provides:
i. what he/she is proud of regarding his/her contribution to RADIAN.
ii. what he/she wants to improve on this year.
iii. how can his/her manager help.
b. Peer review– Employee Owner provides thoughts and ideas on continuous improvement initiatives for the Employee Owner to take based on feedback from a two (2) Question peer review.
An Informal request for peers of the Employee Owner (peers can include direct teammates, Employee Owners in other departments, etc.) to answer two (2) questions pertaining to the Employee Owner.
There should be at least two (2) peers chosen by the Employee Owner, and at least one (1) chosen by the manager, 3 to 8 peers in total, to answer two (2) questions:
1. What should I continue doing?
2. What can I do differently?
Managers: Moving from Boss to COACH
C - Communicate with Empathy
• Listening Skills
O - Optimize Feedback
• Learning to optimize feedback for growth.
A - Access Employee Owner Strengths
• Identify and develop individual strengths.
C – Create a Plan
• Assist employees in creating a growth plan.
H - Hold Accountable
• Moving from Boss to Partner for Growth
Employees: Moving from Principal’s office to owning growth.
Employee Driven
Employee owns initiating and scheduling the discussion
Employee owns needs and results
Employee creates improvement plans
Employee owns growth and success
1. Improve two-way communication
a. Equip Employee Owners with understanding and skills to make the most of twoway discussions allowing for greater flexibility and responsiveness to the needs of the Employee Owner and the business.
2. Help employees demonstrate accountability for personal growth
a. Fosters the RADIAN Culture of Continuous Improvement.
3. Understand what employees need from their manager to improve performance
4. Track output to improve performance
5. Increase Employee Owner Satisfaction
Has helped to created a clear alignment between what I do and the corporate goals.
Very grateful to have been included in the implementation and continuous improvement of the process – like adding the Top Level Corporate Objectives to the form.
Pleasantly surprised the process did take less time with greater impact.
Helped me identify for myself my career objectives and how to create the path to get there.
Tim Everidge
President & CEO
Radian Research, Inc
Lafayette, IN
everidge@radianresearch.com
Renée Mundell
Manager – Customer Service & Support
Team Lead – RADIAN ESOP Ambassador Team
Radian Research, Inc Lafayette, IN
rmundell@radianresearch.com
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Who’s in the Room Today?
Who is attending their first NCEO conference?
•
Who is an owner of company?
Who is an employee of a company? •
•
Who is an employee-owner of a Company?
Why type of employee ownership mechanisms does your company have?
• Nontraditional path to becoming a CPA
• Exposure to open-book management
• Exposure to employee ownership
• Falling into a career in employee ownership
• Giving back to the cause
• Learn about the continuum of employee ownership
• Know the advantages and disadvantages of each form of employee ownership
• Understand how some forms of employee ownership can be used to ease into employee ownership and how some can be combined to meet everyone’s long-term and short-term goals
1773 - Benjamin Franklin’s print shops
• Sent journeyman employees to cities to set up print shops
• Franklin paid the up-front costs and 1/3 of the expenses
• Took 1/3 of the profits for six years
• Journeymen could purchase the equipment from Franklin with their share of the profits
1792 – American cod industry
• Washington, Jefferson, and Hamilton all agreed on one of the American government’s earliest legislative actions: Providing a tax break to help rebuild the New England cod fishing industry.
• Assistance only given to shipowners with a written profitsharing contract
• 3/8ths to the owner; 5/8ths to the crew
1887 – Proctor & Gamble
• William Proctor’s grandson began a profit-sharing program
• By giving employees a stake in the company, they were less likely to go on strike
1916 – Sears Roebuck Company
• Funded its pension plan primarily with company stock
• Provided good retirement benefits
• Excellent way to motivate employees
1940s – Louis Kelso
• Shared with the world his concepts for distributing capital more equally
• Believed that without broader ownership of significant amounts of capital, “many economic and social problems will prove intractable, making the expansion of government’s role in the economy, and perhaps socialism, increasingly unavoidable.”
1974-1986 – Louis Kelso and Senator Russell B. Long (D-LA)
• Passed 17 laws encouraging employee ownership
• Including the ESOP provisions of ERISA
Employees think and act like owners
• Teach people how the company makes money
• Share performance data
• Train people in business literacy
• Build employee involvement
Cost: ↓ Low
Governance: No change
Complexity: ↓ Low
Goals: Long-term
Regulation: ↓ Low
Rewards: N/A
Advantages:
• Employees feel and act like owners
Disadvantages:
• No actual ownership
• No government regulation
• Scalable
• Improves company performance & job satisfaction
• Takes a significant time and commitment from management
• No direct financial rewards
• May be seen as a gimmick
Bonuses are a payment or incentivized reward added to an employee’s compensation package. Companies use bonuses to increase productivity, improve retention, thank employees for their efforts, and create a positive work environment.
• Discretionary bonuses are determined at our company’s sole discretion.
• Nondiscretionary bonuses are promised to employees and guaranteed to those who meet established criteria.
Cost: ↓ Low
Governance: No change
Complexity: ↕ Medium
Goals: Short-term
Regulation: ↓ Low
Rewards: Immediate
Advantages:
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership
• Little regulation
• Easy to implement
• Easy to understand
• May produce conflicting financial results
• Unintended consequences
• No long-term incentive
Performance awards are designed to pay out (in cash or stock) for performance over a few to several years, rather than annually.
Based on long-term improvements in: • Sales
Quality
Cost: ↓ Low
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↓ Low
Rewards: Delayed
Advantages:
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership
• Little regulation
• Easy to implement
• East to understand
• Focuses on long-term goals
• May produce conflicting results
• Unintended
consequences
• Multi-year commitment
Profit sharing are a qualified retirement plan funded with a portion of the company’s profits.
• In profit sharing plans, the company contributes a part of its profits into a pool of funds to be distributed among eligible employees.
• Profit sharing plans are qualified retirement plans that may be offered in lieu of or in addition to traditional retirement plan, like a 401(k) plan.
Cost: ↓ Low
Governance: No change
Complexity: ↕ Medium
Goals: Short-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership
• Highly regulated
• Easy to implement
• East to understand
• No long-term incentive
• Can be opaque
Stock Appreciation Rights (SARs)
Restricted Stock Units
Phantom stock
Stock appreciation rights provide a right to the monetary equivalent of the increase in the value of a specified number or shares over a specified period of time.
• Usually paid out in cash
• Can be paid in shares (usually called a “stock-settled stock appreciation right”)
Cost: ↕ Medium
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership
• Can be difficult for employees to understand
• Equity-like experience
• No tax benefits to employees or employer
Restricted stock units are similar to a phantom stock (discussed next). Employees are given a restricted right to receive a payout of shares at a future date or subject to a performance condition.
Cost: ↕ Medium
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership until settled
• Rarely receive dividends or carry other stock rights
• Equity-like experience
• Subject to deferred compensation tax rules
Phantom stock is a reward paid to an individual for the value of a defined number of shares.
• The reward is not actually made in shares but in a promise to pay the employee the value of the shares at some point in the future.
• The reward is usually paid in cash but could be paid in shares.
Cost: ↕ Medium
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership
• Can be difficult to explain to employees
• Equity-like experience
• No tax benefits to employees or employer
• Employee Stock Ownership Plan (ESOP)
• Employee Ownership Trust (EOT)
An Employee Stock Ownership Plans (ESOP) is a defined contribution plan under ERISA.
• Funded entirely by employer contributions
• Invests primarily in employer stock
• The only retirement plan allowed to incur debt
Cost: ↑ High
Governance: Vote on some issues
Complexity: ↑ High
Goals: Long-term
Regulation: ↑ High
Rewards: Delayed
Advantages:
• Significant tax advantages
• Provides significant retirement benefits
• Employees share in the results of their efforts
Disadvantages:
• Regulated by the DOL and IRS
• Expensive to setup and maintain
• The ESOP Trust is a single shareholder
• No immediate cash reward for employees
An employee ownership trust (EOT) is a form of employee ownership that is relatively new in the United States. To become an EOT company, the current owner creates a trust that will own some or all the business.
• No legal definition separates an EOT from similar trusts
• The purpose should include the well-being of the company’s employees
• The trust may include other purposes
• Often includes profit sharing pool for employees
Cost: ↓ Low
Governance: Based on Trust doc.
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↓ Low
Rewards: N/A
Advantages:
• Preserves the character of the business
Disadvantages:
• Relatively new in the US
• More flexible than other forms of employee ownership
• No tax advantages to selling owner or company
• Employee stock options
• Employee Stock Purchase Plans (ESPPs) • Restricted Stock • Worker cooperatives
The company gives options on the company’s stock. These options are in the form of regular call options that give the employee the right to buy the company's stock at a specified price for a finite period of time.
• Qualified Options are granted to key employees and top management and receive capital gains tax treatment.
• Non-qualified Options are granted to employees at all levels of a company, board members, and consultants and receive ordinary income tax treatment.
Cost: ↕ Medium
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Some tax advantages
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• No actual ownership until exercised
• No immediate cash reward for employees
• Dilutive on exercise
In an employee stock purchase plan, employees can purchase shares with their own funds, either at market or at a discount.
• In some cases, employers provide below-market or nonrecourse loans to help employees purchase the shares
• Employee hold shares as individuals with the same rights as other holders of the same class of security
Cost: ↓ Low
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Delayed
Advantages:
• Actual ownership
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• No immediate cash reward for employees
• Employees could feel pressure to invest
• Brings new capital into the company
• Market for sale of shares may not exist
In restricted stock plans, employees would be given shares or the right to buy shares (perhaps at a discount), but could not take possession of them until some time later when certain requirements have been met, such as working for a certain number of years or reaching a certain size.
• Restricted stock can be dividend eligible
• Restricted stock can be allowed to vote
Cost: ↓ Low
Governance: No change
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↕ Medium
Rewards: Mostly delayed
Advantages:
• Actual ownership
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• Restrictions may make benefit unlikely
• Market for sale of shares may not exist
• Unlike options, retains some value, even if stock price drops
Worker cooperatives are business entities that are owned and controlled by their members, the people who work in them.
• Worker-members invest in and own the business together, and it distributes surplus to them
• Decision-making is democratic, adhering to the general principle of one member-one vote
Cost: ↕ Medium
Governance: Democratic
Complexity: ↕ Medium
Goals: Long-term
Regulation: ↑ High
Rewards: Immediate
Advantages:
• Actual ownership
• Focuses on long-term goals
• Employees share in the results of their efforts
Disadvantages:
• Dependent on state law
• Can be difficult to finance
• Change to democratic management can be difficult
• Dividends allocated to members are not taxed
Organizations: National Center for Employee Ownership (NCEO)
nceo.org
The ESOP Association
esopassociation.org
Democracy at Work Institute institute.coop
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At the end of the session, you will be able to:
• Understand the difference between ESOP distribution policies
• Identify what steps the company can take to manage employee benefit levels
• Learn how different debt structures can impact the company’s short-term and long-term cash flow
• Basic Transaction Financing Structure
• Controlling cash flow in the short term
• Synching Up long-term and short-term
• ESOP plan design impact on long-term cash flow
• What determines benefit level and how does it impact future cash flows?
• Future flexibility
• Breaking down the capital stack:
• Senior Debt:
• Mix of asset based, cash flow or second lien loans
• Lowest cost financing alternative
• Typically, 2-3X EBITDA
• Mezzanine:
• Subordinated, generally unsecured
• Typically, Interest-Only Payments
• Possibly another 1-1.5X EBITDA
• Seller Notes:
• Subordinated, generally unsecured
• Fund remainder of purchase price
• May also include warrants on top of coupon rate
• Typically, a 5-year term; although stronger credits with collateral may seek a 7to 10-year amortization schedule
• Collateral shortfalls expected; can mitigate with cash flow recapture
• For companies on the lower end of the EBITDA range for an ESOP (<$2 Million of EBITDA), personal guarantees or pledge of proceeds may be required to mitigate the risk of the collateral shortfall, industry or customer concentration, etc.
• Subordination of remaining notes to fill out the debt stack with interest payments allowed with covenant compliance
• Loan Covenants Include: Senior Debt/EBITDA, Total Debt/EBITDA with the greatest focus on Fixed Charge Coverage Ratio/Debt Service Coverage Ratio
Fixed Interest Rate vs. Interest Rate Swap:
• What is an Interest Rate Swap?
• An agreement between two parties to exchange one stream of interest payments for another, over a set period of time. The most common and most liquid exchange fixed-rate payments for floating-rate payments
• An interest rate swap can give both parties what they want, but are they for everyone?
Fixed Interest Rate
Pros:
- Simple
- Easy to Budget
- Smooths cash flow
Fixed Interest Rate
Cons:
- Likely higher than floating rate
- Prepayment Restrictions
Interest Rate Swap
Pros:
- Provides company with fixed rate and bank with floating rate
- Easy to budget
Interest Rate Swap
Cons:
- Can be complex
- Prepayment
Restrictions
- Termination fee if rates decrease
Variables That Can Impact Cash Flow
• What is your net EBITDA?
• Annual CapEx Requirements
• Existing Debt
• “Levers” to pull to help cash flow
• Loan Amortization (Downside?)
• Seller Note Interest; Cash and Paid In Kind
• Future Plans outside of ESOP
• Acquisition Targets
IRS contribution limits
Corporate tax deductions
Allocation formulas
Distribution policy
• How many years should the loan be?
• Loan amortization – required annual payments
• How quickly shares are allocated
• IRS limits on contributions
• How many shares will need to be repurchased and when
• S distributions/dividends needed
Required annual principal and interest
• IRS limits contributions to 25% of eligible compensation
• Will required annual contributions exceed IRS limit?
• What about future contributions to repurchase shares?
• S distributions to fund excess over IRS limits and impact
• Is company trying to maximize corporate tax deductions?
Transaction structures impacting internal loan terms:
• Direct sale to ESOP
• Redemption followed by sale to the ESOP
• Partial redemption and sale of rest to ESOP
• Redemption followed by contribution of shares to ESOP
• Length of loan determines level of benefit
• Shares released and allocated over term of the loan
• Benefit level determined by the value of shares released and allocated annually (share value x number of shares allocated)
• Benefit level also includes:
• Contributions to other plans and/or to ESOP not used for loan
• Forfeitures
• Contributions to repurchase shares
Contribution % equals amount contributed/eligible compensation
Benefit level equals value added to account/eligible compensation
Value of shares released from contributions may be
or > contribution amount
• The faster shares are allocated the sooner they must be repurchased
• Once allocated – subject to distribution rules
• What is the right distribution policy
• Can it be changed?
• What is strategy for repurchased shares?
• Redeem
• Recycle
• Can change over time
What things can be changed after the ESOP is established?
• Eligibility – make less restrictive
• Pay down internal loan faster
• Distribution policy
• Share repurchase strategy • Other
• Model out/project potential impacts of plan design
• Compare alternatives
• Stress test assumptions
• Share price growth
• Growth in workforce
• Alternative distribution policies
• Make sure results align with myriad objectives
• Cash flow, tax deductions, benefit level, employee ownership
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.
2798570-032023
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• Learn practical strategies for recruiting employee owners
• Learn practical strategies for retaining employee owners
• Hear your strategies for recruiting and retaining employee owners
• In small amounts, turnover keeps the organization fresh with new talent and ideas
• When churn rates for employees are high, businesses spend time and money training new hires while losing out on potential new clients and revenue
• Employee turnover costs can equal up to one-third of the employee’s annual salary
• Three out of four employee resignations can be prevented
• Company turnover can be reduced by 29% to 59 if employees are aligned and engaged
• The national unemployment rate is at 3.4%, the lowest it has been in 60 years despite the prominent stories about layoffs in high tech
• The same is true for all 4 regions of the country
• This means you have to outperform the competition
Are you using the fact that you are an ESOP in recruiting and retaining?
Join a world leader in energy measurement and start your ownership journey today!
Radian Research is an employee-owned innovative technology company with an engaging and participative work environment. The focus of Radian is our customer, and the heart of Radian is our team. We recognize and value the 3 Cs of Radian’s culture: Customer-centric focus, continuous improvement mindset, and care for our Customer, company, community, and for each other.
26 % of workers who resigned from a company regret that decision
They might have left for more $ or more flexibility.
Motivation research tells us that once you have “enough” money to meet your needs, more money is not a motivator
If you know what motivates them to leave/stay, you might be able to do something about it
Use a series of stay conversations to find out and revisit often
Exit interviews occur too late
Healthcare affordability
Pandemic, Societal Unrest, Inflation, and the Great Resignation Collide
Poor mental health and substance misuse at record high levels
DEI and SDOH, and health disparities come into focus Work/Life balance
Expanded life stage support
(Reproductive/Leave/ Caregiver)
Tight labor market heightens need for robust employee benefits offering
Continued health deterioration and delayed care
Inclusive benefits and perks
• Implement more virtual health opportunities (such as mental health, physical therapy, digital coaching and condition management), 54%
• Expand access to mental health services, 47%
• Implement initiatives to reduce health inequities within health plans, 24%
• Expand centers of excellence to include additional conditions (such as cancer and infertility), 22%
• More-focused strategy on high-cost claims, 22%
• Implement high-performance networks, 16%
• Eliminate out-of-network coverage for select services, 6%
• Consolidate/reduce number of virtual health solutions offered, 5%
• Indeed, JAzzHR, LinkedIn, texting services, Facebook, peer Recruits
• Retention bonus, wage increases
• Employee referral bonus, sign-on bonus, stay bonus
• Quarterly profit sharing
• ESOP
• Increased culture, manager and employee training
• Career fairs, summer interns
• Stay interviews
• Updated marketing
• Total compensation package, competitive benefits (free health insurance), cafeteria plan
• Flexible work from home hours
• Improved communication
• Increased PTO time, moving to responsible time off
How do you feel about the benefits your company offers?
ⓘ Start presenting to display the poll results on this slide.
• Wage increase, retention bonus, productivity bonus, Christmas bonus
• Parental and maternity leave
• Caregiver leave
• Commuter benefit
• Enhanced time off including sick leave
• Enhanced dental and vision coverages
• Whole life insurance
• Pet insurance
• Flexible reimbursement account
• HSA
• Flexible work policy
• EAP
• Home office equipment
• Relaxed dress code
Are you using the fact that you are an ESOP in recruiting and retaining?
Job Advertisements
Screening conversations
Interviews
Job Offers with
Illustration of Total Rewards
Leadership Meetings with Break Out Sessions to share ideas
Communication
Our Values
Collaboration & Respect
Transparency of Business
Objectives and Results
Create a Talent Acquisition Strategy to acquire employees for long term success
Develop an effective Recruitment Strategy to fill positions quickly
Having the right people lined up to fit open positions now & in the future
Getting People Onboard, On Time!
Longer View/Vision
Prepares the Foundation
Short Term Goals
Fill the position
1. Get serious about your Company Branding; showcase your ESOP culture
2. Appeal to the right audience; use the right words; “Hunt” for the right candidate
3. Research & invest in helpful external services
What’s your Talent Acquisition Budget?
Selling the Company & The Opportunities
Continuously assess your current process, find gaps & make improvements
Develop your Key Performance Indicators & Create Metrics that Matter
Nurture Candidates with your Internal Process
Interview Training
Total Rewards
• Strong Leadership
• Frequent Feedback
• Good Work/Life Balance
• Opportunities
• Competitive Pay Packages
Growth Opportunities
Great Work Environment
Strong Onboarding Strategy
Our Culture, Aligned with Our Mission, Vision & Values
Rewards & Recognition Program
Employee Engagement
peter.aliferis@pendoadvisors.com
Brian Hector Partner
Morgan, Lewis & Bockius LLP brian.hector@morganlewis.com
Kjersti L. Cory Independent Trustee SCJ Fiduciary Services
kjersti@scjesop.com
1. Scan the session QR Code on the door or directional signage nearby
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4. Complete the CE Survey.
Synthetic equity is not actual ownership in a corporation
– No dividends
– No voting rights
– No right to information or dissenters’ rights
Value is typically paid in cash and determined based upon the value of a company’s common stock at a set point in time
Two common ESOP settings in which synthetic equity is issued
– Transaction Warrants
– Compensatory (typically executive) situations
Stock Appreciation Rights (appreciation award)
Phantom Stock (full value award)
A warrant gives the holder the right, but not the obligation, to purchase equity securities from the issuer at a specific price within a pre-established time frame
–
–
–
–
-Economically similar to a call option, although issued by the company
-Typically issued at fair market value (i.e., strike price)
-Economically dilutive to common stockholders
-Warrants are typically taxed at capital gains on all proceeds
In corporate transactions (including ESOP companies), warrants are often issued in conjunction with subordinated debt
–
-Reduces current cash flow required to service debt (i.e., deferred interest)
– -Provides company with access to financing that would otherwise not be available
–
–
-Provides additional, equity-like, rate of return to lender to compensate for higher risk
-Offers some protection to the ESOP on the downside
When analyzing a transaction with seller notes and warrants, one should ensure that the internal rate of return (“IRR”) to the seller does not exceed what is reasonable and appropriate, given prevailing capital market costs for debt financing with similar risk characteristics
–
-IRR typically between 10% - 15%
Includes interest rate on the seller note and valuation of the warrant
In certain, less common, ESOP transactions, warrants are purchased directly by investors as a form of equity transaction financing
– Typically, the current shareholder group, along with potentially board of director members and executive management team members
– Provides the company (and ESOP) with access to equity financing that would otherwise not be available
– Provides direct equity exposure for the investors, along with the rewards and risks of such an investment
–
Offers some protection to the ESOP on the downside, as warrant equity is effectively “subordinate” to ESOP equity based on the strike price of the warrants
– Can offer management team members more equity exposure to the company, but with capital gain tax versus ordinary income characteristics
Use of synthetic equity as a benefit above and beyond the ESOP can be a complementary motivating instrument and is typically considered part of an LTIP
Synthetic equity is a strategic way for companies to attain the four “R’s” in order to remain competitive within the overall marketplace:
– - Retention
–
-
– -
–
-
Recruitment
Reward
Retirement
Synthetic equity plans are often used by companies to align management incentives with the returns provided to shareholders
–
- Motivates performance to achieve targeted financial objectives, i.e. the “transaction model” or long-term projections being used for the ESOP appraisal
-
–
–
–
-
-
–
–
Wealth accumulation based on financial performance
- Typically targeted to key employees
Part of total compensation, LTIP category
Market-based compensation, by dollar opportunity as well as total corporate dilution
- Performance benchmarks
Typically, issued at fair market value (i.e., strike price) and can be retention based or performance based
Includes a term to maturity, vesting requirements, criteria for issuance
Value of security dictated by value of common stock relative to strike price
Economically dilutive to common stockholders
Advantages
–
Long-term motivation of employees tied to shareholder gains
– Avoids issues of minority shareholder rights
– Employees do not have to actually purchase shares
– Company receives tax deduction when SARs are settled
Disadvantages
– SARs are considered liabilities and must be valued every year until settled
– Typically, settled in cash, so represents a potential cash drain on the company upon settlement
– Employee pays ordinary income tax on all proceeds
Typically, equivalent in value to value of common stock (i.e., no strike price), but holder does not enjoy the same rights as those of a common stockholder (e. g., voting rights, potential dividend rights, etc.)
Includes a term to maturity, vesting requirements, criteria for issuance
Economically dilutive to common stockholders
Advantages
–
Long-term motivation of employees tied to shareholder gains
– Avoids issues of minority shareholder rights
– Employees do not have to actually purchase shares
– Company receives tax deduction when settled
Disadvantages
– Potentially rewards employee even if share price does not go up
– Typically, cash settled, so represents a potential cash drain on the company upon settlement
– Employee pays ordinary income tax on all proceeds
Incentive stock options (ISOs) –formal stock option plan – LTIP C-Corps, typically
– Numerous requirements
Non-qualified stock options (NSOs) –options that do not meet the terms of Internal revenue Code 422 – LTIP C-Corps, typically – Offer more attractive tax terms for company than ISOs
– Less burdensome to meet IRS rules
Cash awards – Short term bonus plans
– Executive bonus plans
Performance based
Annual plan
– Deferred compensation
– All amounts are taxed as ordinary income
Should the ESOP Trust hold all of the equity value?
Many ESOP companies target equity value using SARs and warrants
The valuation should consider the economic cost of all synthetic equity when valuing an ESOP company
Synthetic equity is a key factor when reviewing the fairness of an ESOP transaction taken as a whole
– Retention based versus performance based synthetic equity when implementing a transaction
– Total warrant amount and its contribution to IRR in the overall transaction
It is important to understand the company’s philosophy of how it regards synthetic equity plans during the valuation process
– One time grant?
– Normal compensation for a group of employees?
– New awards granted each year?
– Annual valuations should include economic dilution to stockholders from outstanding synthetic equity units, as appropriate
General Lender Considerations
– Cash flow effects on synthetic equity
– Transaction warrant exercise period almost always falls beyond the maturity date of the senior financing
– How will the future liability of synthetic equity be funded?
Senior/Lender Debt
Cash paid via company liquidity
• This could affect future uses for cash, such as acquisitions, CapEx, growth and repurchase obligations
Issuance of actual securities, which may be dilutive to shareholders
–
What is the valuation impact and total IRR consideration?
– Management is properly aligned with the performance of the company and locked-in.
Important consideration in a transaction where long-time ownership fully exits the company
– Ensure synthetic equity is in compliance with all statutes (409(p), etc.)
– Liability accounting value of synthetic equity will generally not be included in the leverage test, unless the liability can be cash triggered prior to senior debt term expiring
– As senior debt leverage decreases, the ability to “re-load” and cash out synthetic equity becomes more attainable
– Actual cash payments from synthetic equity awards included
Similar to annual required repurchase obligations
– Accounting expense charges for increase in liability value typically not included
The company is an industrial machinery dealer and full-service rebuild shop that buys, refurbishes and resells used oil field equipment. The company specializes in pumps, engines, generators, compressors, pump parts, gearboxes, and other rotating industrial equipment
Transaction Structure
– The company redeemed 100% of the company’s outstanding common stock from the selling shareholders for $25 million (the “Redemption Price”) in exchange for $10 million in cash and $15 million in seller subordinated notes (the “Seller Notes”)
– The Seller Notes had the following attributes:
Maturity at the end of five years with cash interest of 5.0%
• Straight-line amortization
The Seller Notes were issued with warrants to purchase an aggregate of 20% of the company’s outstanding common stock (the “Warrants”)
– The ESOP acquired 1,000,000 newly issued shares of common stock from company treasury and was financed with a loan between the company and the ESOP (the “ESOP Loan”)
– The ESOP Loan is payable over twenty years in equal annual installments of principal and interest.
– Interest payable at the current annual long-term Applicable Federal Rate (as defined under yearly IRS guidance)
Retention-based SARs
– Subsequent to the ESOP transaction, the Board of Directors of the company adopted a management incentive plan in the form of retention-based SARs (The “Retention SARs”). The Retention SARs accounted for 3% of the equity of the company on a fully diluted basis, and was granted to the company’s key management at post-transaction fair market value.
– Retention SARs:
3% of the Company's equity were issued immediately following the closing date
The Retention SARs were assignable and immediately vested
The Retention SARs are exercisable after a 5-year lock-up period
The Retention SARs are payable over a 3-year period upon exercise
Performance-based SARs
– Post-transaction, up to 12% of the company's equity may be issued to key management as performance-based SARs (the “Performance SARs”). The Performance SARs shall be subject to a maximum of 2.4% of the Company's equity-- to be issued each year and split between key management upon achieving 105% or more of the company's annual ESOP adjusted EBITDA targets, on a cumulative basis.
The expected cash flow from the Seller Notes generates an IRR of approximately 12.0% for the Selling Shareholders. The IRR is then compared to expected market returns
Transaction award vs. post-transaction plan
Full value awards vs. appreciation awards
Short-term, mid-term, or long-term time horizon
Performance vs. retention
Participant flexibility
Participant elective participation
Questions???
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• Your feedback on topics and presenters is important and will be used to develop subsequent programs
• Remember that you need to scan this sessions QR Code by the door to get CE credit
Peter is a Partner and Head of the ESOP Advisory Group at Pendo Advisors, LLC. He is a seasoned finance professional with experience in ESOP advisory services, fairness and solvency opinions, mergers and acquisitions, valuations for estate planning and financial reporting purposes, leveraged buyouts, management buyout transactions and private placements.
Peter holds an M.B.A with Concentrations in Finance, Economics and Accounting from DePaul University’s Kellstadt Graduate School of Business. Peter also holds a B.Sc. in Finance from DePaul University.
Brian D. Hector is a partner in Morgan Lewis’s Employee Benefits and Executive Compensation Practice and co-chair of the ESOP Task Force.
Mr. Hector focuses his practice on ERISA and employee benefits law, including the areas of ESOPs, qualified plans, all types of executive compensation, fiduciary liability, and related securities law issues. Mr. Hector is a nationally recognized ESOP attorney, who has advised several public and private ESOP companies with regard to corporate governance, succession planning strategies, ownership transition, and liquidity transactions.
Phone: 312.324.1160
Email: brian.hector@morganlewis.com
Mr. Hector has served as counsel to companies and shareholders regarding the use of ESOPs in numerous transactions, including equity repurchases, ownership succession transactions, leveraged buyouts, mergers, acquisitions, and corporate reorganizations. He has also represented lenders and trustees in ESOP transactions.
Mr. Hector has an impressive history working with all types of benefit plans and executive compensation arrangements. He has also represented several clients before the IRS and the Department of Labor in connection with ESOP and employee benefits matters.
Kjersti L. Cory, Independent Trustee
Kjersti Cory currently serves as Independent Trustee at SCJ Fiduciary Services, focusing on managing client relationships and ESOP transactions.
Ms. Cory joined SCJ Fiduciary Services in 2022. Prior to joining SCJ Fiduciary Services, Ms. Cory worked in the ESOP Trust department at GreatBanc Trust Company. She has worked with employee-owned companies since the 1990s, providing trustee and ESOP transactional services to clients throughout the country. Ms. Cory’s experience includes the implementation of new ESOPs, secondstage ESOP transactions, redemption and sales transactions, mergers and acquisitions, as well as refinancing, restructuring, bankruptcy and liquidation transactions.
Ms. Cory earned a bachelor of science in business administration, with an emphasis on finance, from the University of Missouri, and a master of business administration from Quincy University. She is a member of the ESOP Association and its Administration Advisor y Committee. Ms. Cory is also a member of the National Center for Employee Ownership and the Ohio Employee Ownership Center at Kent State University
1. Scan the session QR code upon entering the breakout room, using the Annual Conference Event app
2. Participate in the instructor-led question / discussion
3. Complete the CE survey via the session page in the mobile app
Kyla Alterman
Consultant
Jacob Covell
Media Specialist
• Break into groups of 3
• One person start “filming”
• Answer one question:
• What does employee ownership mean to you?
• What is the most important thing employees need to know about employee ownership?
Know your “why” before starting video production!
• Provide consistent message for all employees
• To be viewed in employees’ own time
• Reach a dispersed workforce
• Standardize ESOP onboarding
• Build employee owner skills
• Keep ESOP top-of-mind
• Communicate important information in a new/engaging way
• Teach ESOP basics in small chunks
• Reinforce other meetings and training
1. Identify needed video modules.
2. Collaborate and write scripts for your videos.
3. Storyboard and offer visualizations.
4. Capture content, pull from existing catalogue or stock website.
5. Video editing process. Go through multiple edits with your team to ensure the video captures your message in a clear way.
• Find employees that are excited & willing to work with you.
• Document everything related to your educational series.
• Let other locations know what you're looking for.
• Find a stock photo/video site that fits your needs to fill in the gaps.
• Hire an editor to put your series together if you don’t have an in-house team.
• Find a testing system that works for your team.
• What quality do you want the video to be?
• Do you have a budget?
• Do you have a team to create or co-create the video?
• Do you want to hire professionals to create or co-create with you?
• Who will write the script and storyboard the video?
• How will the video be viewed/where will it be kept?
Recorded Teams/ Zoom call
Hybrid interview with slides or animation
Animated
PowerPoint
Professional
Videography
Professionally
Animated
• 2-5 minute training videos
• Short quiz after each video
• Assistance with script and storyboards
• Hired a professional animator
• AACE-Award winning program
• Helps employees appreciate ESOP
• 2,000 employee owners with typical 50% turnover
• Among employees who earned CEO certification, retention rate is 97%
• Communicate ESOP basics and company values
• Messages reinforced with biweekly nuggets
• Interviews with key people involved in the ESOP
• Committee involved in selecting new topics
• Personalized training that uses annual ESOP statement to communicate ESOP plan's benefits
• Shows employee owners how the ESOP works and builds ownership culture
• Enter in a raffle
• Swag & prizes
• Make it mandatory
• Lead up to in-person event • Watch in group meetings
What have you done at your company to get participation?
• Build into onboarding
Kyla Alterman Consultant
kalterman@workplacedevel opment.com
Jacob Covell Media Specialist