AC 23 Concurrent Session 7

Administrative Tips to Protect Your Plan by Satisfying DOL or IRS Inquiries

Jose M. Jara, Esq.

Sandy Birdsong, CPA

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

Internal Controls Definition

“ Internalcontrolsarepoliciesand proceduresdesignedtohelpyoudetect andpreventerrors. Stronginternal controlsareimportanttoprovidea reasonablelevelofassurancethatyour planisoperatingproperly.”

- IRS Website

IRS Internal Controls

Employee Plans Correction Resolution System

Effective practices and procedures is a basic requirement for use of Self Correction Program under EPCRS.

“You must routinely follow established policies and procedures to be eligible to self-correct many plan errors under the IRS plan correction programs”

-IRS website

DOL Investigations and ERISA

- Authority to investigate

- Fiduciary Duties

- Prohibited Transactions

- Fiduciaries – 3(21)

- Parties in Interest

- Statute of Limitations

DOL Fiduciary Investigations Program

“Report of Investigation”

“Where appropriate this section of the report should include, but not be limited to, information concerning: identities and principal duties of all plan officials and principal employees and service providers during the relevant period, including dates of service; funding method; internal controls; investment policies and practices; benefit payment procedures; collection of contributions; and other relevant information relating to plan administration and financial operation.”

- Employee Benefits Security Administration, Enforcement Manual

Areas of Focus

- Selection and Monitoring of Service

Providers

- RFP process

- Missing Participants

- Loans

-

Hardship Withdrawals

- Cybersecurity

- Excessive Fees

-

Claims

Procedures

Where to Start – Define Controls

Well Documented Controls that are Operationally Followed

Create Checklists / Process Documentation

Eligibility

▪ Plan document defines service and entry dates

Changes

▪ Deferral changes entered into payroll correctly

▪ Roth or Pretax - KSOP

Enrollments ▪ New participants enrolled timely

▪ No participants enrolled prior to eligibility

Rehires ▪ Follow plan document – high potential of error

Timely Deposits

No Late Contributions

▪ Typically 3 business days - employee deferrals and loan payments (KSOP)

Other Documentation

▪ Plan Definition of Compensation followed

▪ Accuracy of data

▪ Ownership

▪ Indicative data responsibility of plan sponsor

▪ DOB, DOH, DOT, DORH

Where to Start – Define Controls

Other ESOP Processes

Diversification ▪ Qualified participant

▪ 10 years of participation and age 55

▪ Definition of participation (not provided in Notice 88-56)

Distributions ▪ Eligible participant

▪ Form of distribution

▪ Timing

▪ Distribution Policy

Share Price History –Closely Held

▪ Appropriate share price is crucial

▪ Diversifications

▪ Distributions

▪ Participant valuation

Recycling Processes ▪ Is the process clearly defined?

▪ Who is eligible to purchase available shares?

▪ Terminated participants – excluded?

▪ Shares available from diversification excluded from repurchase by participants who diversified those shares?

Annual Audits Focus

Enhance or Tailor Internal Controls

Operational Focus

▪ Timely Remittance of Contributions

▪ Eligibility

▪ Compensation

▪ Withdrawal Options

▪ Distributions and Vesting

▪ Contribution Calculations

Plan Form Focus

▪ Timely Plan Amendments

▪ Signed Plan Documents

▪ Required Notices

▪ Nondiscrimination Testing

▪ Use of Forfeitures

▪ Fees

▪ Required Disclosures

▪ Diversifications

▪ Recycling or Rebalancing

Fiduciary Responsibility

For Plan Sponsors

• Plan Sponsors should meet with their consultants routinely to discuss their plan administration and compliance items for them.

• It is still your plan , and you have the ultimate responsibility for its health.

• Create a “Team Mentality” where both the Plan Sponsor and Consultants are working together.

even if the plan hires a “Third Party Administrator to assist in Plan administration, they can NOT place internal controls on the back burner”

Fiduciary Responsibility

Review of Service Providers

Annual Reviews SSAE 16 –SOC 1, 2 & 3

 Review updates from plan sponsor records

 Report of internal controls for service provider

Choose Reputable Service Providers

 DOL Audit Quality Study

Document Retention

▪ Participant Records

▪ Plan Documents

 Most errors occur with auditors not well versed in plan audits

▪ Committee Minutes

 Independent and experienced valuation firms

Secret Word for CE

Action Items

In Summary

1 Review your current processes

2

Document the controls you have in place

3

Add controls and documentation based on Gap Analysis

(What is needed versus what you have)

4

Work with your consultants/attorneys

5

Consult websites for additional information: www.irs.gov www.dol.gov/ebsa

Questions?

Jose M. Jara, Esq.

Sandy Birdsong, CPA

Board Governance Through the Lifecyle of an ESOP

Steve Ryan GreatBanc Trust Company

sryan@greatbanctrust.com

Sandy Shoemaker Shoemaker Consulting LLC

sandy@shoemaker-consulting.com

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

Learning Objectives for Session Participants

 Gain information on the value of good corporate governance.

 Learn from peers and professionals on roles and responsibilities.

 Able to ask direct questions or share governing experience.

Corporate Governance Structure

Board Formalities

By Laws:

• Establish governing procedures

• Robert’s Rules of Order

• Director terms, define officers and roles

• Meeting frequency, notice, voting, quorum

Board Officers:

• Chairperson – Agenda setting, encourages discussion, casts deciding vote only if necessary

• Treasurer – Responsible for obtaining and presenting accurate financial information

• Secretary – Maintaining minutes and records (does not need to take them)

• Shareholder

• Board Member/Chairperson

• Former Owner/Selling

Shareholder/Lender

• Trustee

• Chief Executive/President

• Chief Financial Officer

• Senior Management • Employees/Union Rep

• Vendor/Customer

Juggling Hats

Recognize potential conflicts, avoid or manage them, and act in good faith.

Members of the Board of Directors

• Member • Chairperson • Secretary • Committee Chairperson • Committee Member • (“Lead Director”)

Who should serve on the Board?

• Non -members (Advisors)

Duties of the Board

Duty of Care

• Must inform themselves prior to making the decision

• Quality of information, advice considered, sufficient time to consider the issue prior to acting

• Company operations, financials, industry, competition, business cycle

Protections

• Good faith reliance on reports and records

• Good faith reliance on financial statements

• Good faith reliance on experts

• “Business judgment” rule

Duties of the Board (cont’d)

Duty of Loyalty

• Undivided/unselfish loyalty to the company

• No interested transactions; cannot profit from corporation’s confidential information; cannot take any action solely or primary to entrench oneself in office

Protections

• Directors recuse themselves from potential interested transactions

• Retain independent advisors

Additional Duties of the Board (cont’d)

• Duty of Good Faith – one violates by demonstrating a conscious disregard for one’s duties

• Duty of Disclosure –disclosure of the facts and circumstances relevant to the Board’s decision

• Duty of Confidentiality – may not use confidential information to further one’s own interests

• Duty of Oversight –implementation of the corporation’s internal information and reporting system

Typical Responsibilities of the Board

• Provide Direction

Promote company vision, mission, and values. Work closely with the CEO to direct company success.

• Hire and Retain a Competent CEO

Recruit, retain, evaluate, supervise, and compensate a CEO who achieves company goals.

• Management Performance

See that management adheres to policies and performs according to plan.

Advise/mentor management.

• Perform Duties as Required by Law

Appoint certain duties to committees.

Maintain oversight of committees.

Typical Responsibilities of the Board (cont’d)

• Board and committees meet regularly

• Board sets annual shareholder meeting and board elections

• Board establishes the nomination process and the election of members

• Nomination/Corporate Governance process

• Production of slate of directors

• Trustee discretionary vote

• Succession planning

• Review corporate financial statements and results of audit

• Retain independent auditors

• Review internal auditing functions

• Evaluate senior officers’ performance

• Determine/set senior officer compensation

• Assess timing and needs for successor managers

Board Composition

Size: No mandated requirements, but an odd number will reduce the risk of a deadlocked vote. Check corporate bylaws.

Independence: The absence of relationships that could impair independent judgement. Should be independent in thought and action. Lack of independence could be asserted by shareholders when decisions or performance goes awry.

Diversity: Of thought and action, gender, skills, ethnicity and generational.

Tenure: Boards should experience perpetual development and enhancement, consider staggered terms, term limits, age limits, and periodic performance evaluations.

Dynamics: Discussion not dominated, but should be open and robust, not antagonistic, aimed at discovery and challenge, not necessarily consensus or immediate change. Should strive for consensus for important matters.

Board Engagement Spectrum

• Limited participation

Passive

• Goes along with CEO and management

Approving

• Certifies CEO and management decisions for shareholders

• Basic governing principles of independence and oversight

Governing

• Independent from CEO control

• Steward of corporation on behalf of shareholder

Engaging

• Adds value through experience and skillsets

• Proactive process and communication with CEO/management

Inter vening

• Heightened engagement and proactive decision-making

• Decisive and instrumental in challenging times

Independent Director Considerations

Advantages

• Reduces conflicts of interest (actual and in appearance)

• Provides different perspective

• Adds credibility, trust, and confidence

• Builds networks and resources

• Satisfies lending requirements

• Great for committees (compensation, audit, and nominating/corporate governance)

• Viewed favorably by DOL

Disadvantages

• Can be hard to find (liability and time commitment concerns)

• Lack specific knowledge of business/industry/ESOP

• Confidentiality concerns

• Compensation

Duties of Directors

Represent and protect the interests of the company and its shareholders Protect

Monitor performance of management, see that it does what it says it will do and adheres to board policies Monitor

Perform any duties as required by law Perform

Appoint officers, monitor, and replace if necessary Appoint

Render advice to management Advise

Board Member Knowledge

 Governance and fiduciary duties

 Factors that drive profitability (earnings) and stock value

 Financial goals and strategies

 Financial and competitive risks

 Business objectives/strategic plans

 Business and industry risk and contingent liabilities

 Strengths, Weaknesses, Opportunities, Threats (SWOT)

 The stock valuation process

 ESOP benefits to participants

 How the company manages repurchase obligation

 Strategy for long-term ESOP-company sustainability

Board Member Skills

 Accounting

 Board

 Compensation

 ESOP

 Executive

 Finance

 Human Resources

 Industry Specialists

 Information Technology

 Leadership

 Marketing and Sales

 Operations

 Public Relations

 Risk Management

 Security/Cyber

 Technical

 Governmental  Community Relations

Effective Board Practices

Preparation and participation in Board meetings:

• Provide agendas timely, with insightful materials

o Use KPIs and dashboards with appropriate comparisons

• Come to meetings fully prepared (pre-reading and background work to understand agenda items)

• Typical Standing Committee reports:

o Audit & Financial

o Compensation & Benefits

o Governance & Nominating

o Executive/Succession Planning

o ESOP/Plan Administration

o Special “Ad Hoc”

Effective Board Practices (cont’d)

Set aside time for:

• Educational development

• Strategic discussions

• Corporate financial planning

• Succession planning

• Review ESOP valuation

• ESOP sustainability planning

Effective Board Practices (cont’d)

Trustees can be:

• Committee or individual

• Internal or external Monitor ESOP fiduciaries:

• Review annual activity (valuation and Price)

• Review qualifications and services periodically

• Look at reasonableness of fees

• Set annual schedules

• Manages Trust Assets

• Follows Plan Documentation

Effective Board Practices (cont’d)

Trustees can be:

• Committee or individual

• Internal or external Monitor ESOP fiduciaries:

• Review annual activity (valuation and Price)

• Review qualifications and services periodically

• Look at reasonableness of fees

• Set annual schedules

• Manages Trust Assets

• Follows Plan Documentation

Where to Find Board Members

 Industry Associations

 Community/Business Leaders

 Private Directors Association

Not your friends or family!

 Professional Service Providers

 Professional Search Firms

 Other Board Members

The Basics of ESOP Board Governance

Corporate decision making

corporate formalities

ESOP Corporate Governance

• Legally the same as any ordinary corporation, practically a little different

• Formal board practices are required

• ESOP trustee:

• Appointed by the board

• Trustee has a duty of prudence and loyalty

• Trustee is a passive investor

• Employees may have a say (but not often)

Some Statistics on ESOP Boards

• Median board size is 5 members

• ESOP companies tend to grow the number of board members over time

• 74% have independent (outside) directors

• Most valued members have:

• Specific knowledge (marketing, finance, HR, etc.)

• Industry expertise

• CEO is board chair in approximately 60% of ESOP boards

Source: The 2016 ESOP Corporate Governance Survey, July 2016, NCEO.

Succession

• Identify board terms in bylaws

• Longstanding members vs rotating members

• Encourage board members to share horizons

• Constant awareness of who is available

Advisory Board

•

Does not vote on board meetings

• Given specific assignments

• Often composed of external advisors with specific skillsets and expertise

Helpful for strategic growth

Secret Word Karlaftis

Director Compensation

• Outside directors

• Fixed annual fee, fee per meeting, or combination

• Stock Appreciations Rights or other equity compensation, subject to trustee approval

• How much do you pay?

• Size and industry matter

• Committee involvement

• NCEO compensation survey

• Independent compensation consultant

• Employees are normally not compensated

Putting it all Together

• Board governance starts with knowing basic legal parameters

• Effective decision making requires understanding your role

• Independent perspectives are valuable

• Build your board thoughtfully

• Productive boards require proactive directors Take

• You are not alone; your peers are resources! Charge Watch for Common Issues

Understand the Basics

Cyber Risk: Best Practices for Protecting Your ESOP and Responding to Cyber -Related Incidents

Bennett Whitehouse

Risk Performance Advisor

Raleigh, NC

Chad Duke

Vice President

Nashville, TN

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

Cyber Risk - Objectives

1. Why is it important?

2. Discussion of cyber liability insurance market.

3. Trends in cyber related incidents and claims.

4. Cyber claim scenarios.

5. Cyber risk defenses.

6. Best practices for incident response.

Facts Tell, Stories Sell

• Average cost of a cyber claim in 2021 was $170k.

• Average cost of a ransomware event was $270k.

• Over the last 2 years, Cyber insurance rates have increased by 50% - 120%.

• Over 60 % of all targeted attacks strike small to mid-sized entities.

• 54% of all cyber attacks result in damages greater than $500k.

• More than 85% of companies experienced a cyber breach in the past three years.

Facts Tell, Stories Sell

• Only 39% of companies have a fully-developed and implemented cybersecurity defense strategy.

• 81% of ransomware attacks hit businesses with <1,000 employees; 60% hit businesses with <$50M in revenue.

• Average downtime due to a ransomware attack is 19 days

• 91% of all attacks begin with a phishing email to an unsuspecting victim.

• 32% of all successful breaches involve the use of phishing techniques.

Cyber Liability Insurance

Cyber liability insurance provides coverage to help protect from data breaches and other cyber security attacks on your business.

Coverage can provide both 1st party and 3rd party protections and related costs. Cyber liability insurance can safeguard against devastating financial consequences of a cyber attack.

Costs related to a cyber claim can include lost income due to a cyber event, costs associated with notifying customers affected by a breach, costs for recovering compromised data, and costs for repairing damaged computer systems. Coverage can be customized to respond to a variety of cyber threats:

• Forensic investigations

• Litigation expenses

• Regulatory defense expenses/fines

• Crisis management expenses

• Business interruption

• Cyber extortion

• Betterment

Trends in Cyber Liability Insurance

Cyber premiums grew by 61% in 2021.

Cyber underwriting tightened with a mandatory focus on IT controls and level of security in place.

Currently, average cyber liability renewal rates are averaging between 5% - 25%.

Multi-factor authentication (MFA) is becoming the gold standard to obtain coverage.

The insurance market did see a downward trend in cyber claims through the end .

We expect that this trend, and more competition, will contribute to more moderate pricing going forward.

Increase in contractual requirements specifically demanding Cyber liability.

Trends in Cyber Risk

Top causes of Cyber related losses:

1. Ransomware

2. Outside Hacker

3. Email Compromise

4. Unspecified Cyber Event

5. Staff Mistake

Trends in Cyber Risk

∙ Ransomware incidents accounted for 87% of claims with a Business Interruption component.

∙ Recovery expense has been steadily increasing since 2017. In 2021, the Incident Cost was over 300% greater when recovery expense was incurred.

∙ The average incident cost of claims was almost 3X higher ($494K vs $170K) when sensitive data records were exposed.

∙ Average incident cost for ransomware claims increased from $614K in 2020 to $840K in 2021.

∙ Average ransom demand went up from $383K to $555K in the same timeframe.

∙ Business email compromise (BEC) claims that included wire fraud had an average cost of $185K in 2021.

∙ The five-year average of claims that involved Business Interruption were almost four times greater than a claim that did not involve BI.

∙ In 2021, the average claim involving Business Interruption was almost seven times greater than one that did not.

∙ This is a huge case in favor of building strong defenses and incident response plans. Typically, business with high BI costs are also the least prepared for an attack.

Scott Client – Ransomware Attack

$500,000 ransom paid System down for over a week

Had to rebuild their customer portal and MS Exchange server – no emails, warranty processing, customer service comms

Didn't "get all their data back"

Total cost of the attack = $1.2M+ Business interruption cost = $620K

Scott Client – Funds Transfer Fraud

$10,500,000 potential loss

Affordable housing client whose developer partner had a business email compromise attack Recovered most of the money due to a posttransaction call procedure

Business Email Compromise

Often perpetrated via phishing or data breaches

Can result in a variety of types of attacks

Hackers lurk in your system for weeks/months gathering intel

Building Multi-Layer Defenses

Determine Business

Impact of an Attack

Update and Test Incident Response Plan

People & Technology

Patch Newly Discovered Vulnerabilities

Inventory Known Vulnerabilities

Discover Unknown Vulnerabilities

Patch Known Vulnerabilities

Incident Response

BEST PRACTICES

GOTCHAS

Have a WRITTEN plan that has been TESTED.

Claims reporting – what to report and when

Define roles and responsibilities.

Insurance carrier panel resources

Consider a broader IR team than expected.

Incident response is an IT problem

Attorney client privilege

Print your plan.

Have work and personal contact information for your internal personnel.

Board/executive liability

Preservation of evidence

Owning Cyber Risk

1. Culture of care, compassion and concern

2. Human impact – our digital lives ARE our lives

A. Payroll interruptions

B. Identity theft

C. Layoffs and business closures

D. Extortion of information

E. Late delivery of products or services

F. Funds transfer fraud

G. Personal safety

3. Own the risk like any other risk or responsibility.

Edwards-Helaire Secret Word

Questions?

Bennett Whitehouse

Risk Performance Advisor Raleigh, NC

Chad Duke

Vice President Nashville, TN

ESOP Companies and an Acquisition Strategy

Allison Wilkerson

David Whaley

Kyle Spader

Covered in Today’s Session:

1. Considerations for an Acquisition

2. The Acquisition Process

3. Things to Consider

4. Transaction Types

5. Roles and Responsibilities

Why an Acquisition?

• Geographic planning/expand territory

• Value growth

• Increase revenue

• Add capabilities

• New products/services

• Increase efficiency

• Add to talent pool

• Grow skilled worker set

• Increase Diversity

• Infrastructure investment

• Add technology

• IP innovation

Successful Acquisition

• Pre-transaction planning

• Structuring alternatives

• Due diligence initiatives

• Funding the transaction

• During the transaction process

• Deal pricing/valuation

• Consider employee retention/participation in the acquiring company’s benefit plans

• Retirement plans/ESOP

• Equality compensation

• Other benefits

• Post-closing

• Integration

• Impact of leveraged financing

Pre-Transaction

• Fully develop and articulate a corporate strategy

• Determine that an acquisition strategy is a better alternative than other options

• Organic growth

• Joint venture

• Hiring programs/acquiring people as opposed to an entire company/division

• Identify acquisition targets that align with the corporate strategy

• Enhances capabilities or product/service offerings

• Fills an existing shortcoming in offerings or geographic presence

• Synergistic opportunity (revenue or costs)

• Learning from prior acquisition processes to develop a successful and repeatable approach

Your “M&A Strategy”

• Establish a clear M&A strategy that aligns with business considerations

• Prepare a screening process for considered targets

• Hire investment banker to locate targets

• Include outside professionals in process for evaluation (accountants, legal, human resources)

• Communicate requirements to M&A team

• Requires detailing “who” is M&A team

• What is the “decision making” process?

• M&A team include necessary decision makers or report to decision makers

• Allow for flexibility in decisions

• Prioritize targets and/or target lines of business

• Cross over on customer base?

• Similar or complimentary business lines?

• Develop investment goals

• Consider valuation goals, synergies (appropriate non-synergies), integration ability

• Key risks to transactions

• Culture impact of an acquisition

ESOP Specific Issues

• Understanding how the acquisition and debt will affect the value of stock held by the ESOP

• Structure: Asset Purchase vs. Stock Purchase?

• Tax considerations to seller

• Is the acquisition covered by ERISA rules or is it strictly a “business judgment” question?

• Implicates Trustee Involvement

• Will/When will Target company’s employees become ESOP participants?

• How will acquisitions affect repurchase obligation cash flows?

• Issues arising if acquirer is an older ESOP, whose shares are fully allocated?

• Should Company acquire Target if accretive on a Company-wide basis, but dilutive on a participant basis?

Evaluation of Target

• Review Seller Materials

(Confidential Information

Memorandum or Seller

Financials)

• Evaluate business strategy and key risks

• Preliminary valuation

• Identify due diligence topics

• Consider structural alternatives

• Lay out transaction structure

• Consider bid strategy

• Management presentation

• Review data room

• Refine base case financial model

• Quantify synergies

• Update valuation

Negotiations & LOI

• Goal is non-binding letter of intent summarizing key financial terms and transaction overview

• Involve advisors (legal, financial, tax) early regarding key structure issues

• Creates obligation to proceed in good faith

• Get the target to “stand still” – provide exclusivity – for a short time (a binding provision of the LOI)

• Confidentiality Agreement prior to LOI

• Letter of intent may “cap” purchase price with downward adjustments based on due diligence and normalized working capital levels

• Refundable or non refundable deposits? Break-up/walk-away fee?

Valuation Considerations

• What are factors to consider in the determination of the price to be paid for the Target?

• What’s it worth to us?

• Identify potential synergies

• Consider whether the acquisition will be dilutive to your company’s earnings

• Analyze the forecast for the Target (within your company)

• What’s it worth to them?

• Target’s business and its history

• Financial condition of the Target (including excess cash, debt, growth ability)

• Quality of earnings analysis?

• Analyze the forecast for the Target (individually outside of your company)

• What’s it work to the market?

• Analyze the business and market risks of the Target

• Consider the earnings multiples and discount rate used for your company’s stock

Due Diligence Considerations

• Define Scope and Depth:

• Financial statements

• Customer issues

• Industry issues

• Environmental issues

• Employee issues

• Health care and benefit plans

• Role of internal team vs advisors

• Legal and Accounting Diligence

• Analyze Potential Liabilities/Pitfalls

• Examine Target Agreements with Advisors

• Confirm Acquisition Fit to Company Goals

• Confirm Target Valuation – Resolve Conflicts

• Revise Letter of Intent and/or Confirm Purchase Agreement to Diligence Issues

Financing Considerations

• Financing Issues

• Several potential sources of debt financing

• Senior Lenders – asset based or cash flow based

• Mezzanine Funds

• Seller Financing

• Equity Financing

• Capital injection or loan by acquiring company

• Limited guarantees by seller and/or owner(s)

• General Lender Considerations

• Collateral base (real estate, inventory, receivables, etc.)

• Cash flow

• Character

Tax Considerations

• Purchase of stock of C-Corp Target by S-Corp Buyer:

• Post-closing, Buyer makes Q sub election for Target

• Target subject to built-in gains (“BIG”) tax for 5 years after S-Corp election if there is a subsequent sale of assets(e.g., inventory, receivables, equipment, etc.) for a gain

• BIG tax is corporate level tax for S-Corp Target (as with C-Corp)

• BIG tax would not apply if Target has been S-Corp for at least 5 years or if Target stock is sold

• Income earned/sourced outside of U.S. taxable even with 100% S -Corp

ESOP

• Applies to ESOP sponsor and subs (U.S. and foreign)

• Establish appropriate transfer prices between entities

• Income in certain states (i.e., TN, OH, CA) subject to tax, even if 100% ESOP S-Corp

Transaction Parties & Roles

Roles and Responsibilities of the Various Parties

Board

Trustee

Officers

Negotiating Letter of Intent

Potential Conflicts

• Internal Trustee

• Management Interest in Target •

Board Member Interest in Target •

Anti-dilution Provisions in • Warrants

SARs

Options

Transaction Structure Drivers

Why an asset sale? • Buyers prefer

Why

Why a stock sale? • Sellers prefer

Why

Asset Sale Attributes

Pass Through Voting

• Required on certain “corporate matters”:

• Merger

• Consolidation

• Recapitalization or reclassification

• Dissolution

• Sale of substantially all assets of a trade or business, or

• Such similar transaction – as Secretary may prescribe

• That require a shareholder vote under state law

• Only shares that are allocated to a participant’s account are subject to pass -through voting

• Pass through voting is always required whenever ESOP holds securities that are a “registration-type class of securities”

Stock Sale Attributes

388(h)(10) Elections by Trust

Partially Owned by ESOP

Fiduciary duties

Dissenters’ Rights

Redemption vs. sale to third party

Fairness opinion

Integration Considerations

• Commit to one culture and one “brand”

• Have an integration team

• Have a plan

• Identify surviving IT as part of deal or immediately thereafter

• Identify surviving payroll and benefits servicer as part of deal or immediately thereafter

• Make all big changes as soon as possible following closing

• Identify strengths and weaknesses of acquirer and Target and be willing to evolve

Governance Issues

• Corporate acquisitions generally require Board but not shareholder approval (merger exception)

• Shareholder approval required to authorize additional shares if necessary as part of acquisition

• If majority ESOP-owned, consider Fairness Opinion by financial advisor to ESOP

• Fairness Opinion by Company financial advisor to Board advisable

• Possible ESOP pass through vote

• Board composition post-transaction

• Corporate acquisitions governed by “business judgement” rule

Post-Closing Issues

• Asset Sale

• Wind Down Company

• Ongoing Valuations

• Stock Sale

• Dealing with hold backs – “baskets”

• Funding ongoing payments to note-holders

• Both Structures

• Trustee Indemnification

• Allocating suspense account dealing with ESOP Loan

• Termination of the ESOP

• Timing

• Distributions

Secret Word for CE

Drum Room

Thank You For Attending!

ESOP Companies and an Acquisition Strategy

Allison Wilkerson

David Whaley

Kyle Spader

Flash Fiction: What’s Your Story

Historical Fiction Author

Carris Reels CFO

dave.fitzgerald@carris.net

Session Description

What's your story? Let's talk about how to tell it. Storytelling doesn't need to be a five-volume series. Sometimes the best stories are surprisingly brief. What if we could win over potential new colleagues with a well-crafted story that makes people want to join us, tugs at the heartstrings, and creates a sense of belonging from the very first day?

Your company's stories are a part of your culture and can link the past, present, and future together. What if, with a few choice words, you could enthrall and inspire generations of employee owners? In this session, we'll talk about how studying the elements of fiction can enrich your company's legacy.

Learning Objectives

1. Recognize the power of your company’s stories

2. See the potential value of crafting inspiring stories

3. Give voice to their own stories and how they can add to the company’s legacy

Mark Twain Quote

“If you want me to give you a two-hour presentation, I am ready today. If you want only a five-minute speech, it will take me two weeks to prepare.”

Flash Fiction (definition)

Picture it! Sicily, 1922 (story)

My First Day (story)

What do you make of this story?

Raconteur

How will you tell your story?

Practice makes it better

Learning Objective #1

• Conflict and resolution

• Tension and release

• Mystery and revelation

• Wants, needs, & desires

• Lofty

• Idealistic

• Visionary

• High stakes

• Life or death

• Love or loss of love

• Careers or loss of careers

• Characters need to want something big and important, rather than trivial

Stories That Matter Your writer’s prompt

• Your company’s creation story

• Your company’s ESOP founding story

• Your first day at the company

• Your worst day ever

• Your toughest obstacle

• Your most difficult challenge

• The mistakes you made

• When the odds were against you

• A fear you overcame

Learning Objective #2

• Create a sense of joining • A sense of belonging • A shared experience

• Remembering something that’s otherwise difficult to remember

• A sense of purpose, when you get to the moral of the story

Source: Kyle Wierks, https://kylewierks.wordpress.com/ https://thewritepractice.com/inspirational-stories/

A plain story is quickly forgotten

What does this story need?

Creation Stories are compelling

Learning Objective #3 = Your Story

• Now let’s begin to work on your story

• Make some notes along the way

• Spend two minutes, think, and decide…

What story do you want to tell?

Write the title of the story on a piece of paper or in the notes app on your phone

Your Story – the HOOK

What begins your story?

Grab the audience’s attention right from the start and don’t let go.

• Picture it, Sicily, 1922

• They must have forgotten I was coming.

• Perched on a ledge with a troubled mind.

Most stories have a beginning, middle, and end.

Flash fiction often starts smack dab in the middle. Spend a minute, think, and jot down a working title

Your Story – Plot

• What happens during your story?

• Not dozens, or hundreds of things.

• Many full-length novels focus only on 3 disasters and an ending.

• This is flash fiction. Spend two minutes and sketch out a plot, like this: This happened, then this happened, then this happened, then this happened, until finally, THAT happened.

Your Story - Perspective/Point of View

• Who is the star of your story? Relatable protagonist

• It isn’t always who you think…

? Founder

? Next leader

? Naysayer

? Newbie

? Professional advisor

? You - why not you

Spend sixty seconds, make a quick decision, and jot down a couple of key words.

Characters Welcome - The Wizard of Oz

Protagonist - DOROTHY GALE

Antihero – [The Grinch]

Villain – THE WICKED WITCH OF THE WEST

Nemesis (opposition) [a villain is evil whereas a nemesis is a rival]

Attractor (emotional development) – SCARECROW, TIN MAN, COWARDLY LION

Mentor (intellectual devt.) – GLINDA, THE GOOD WITCH

Trickster (switches from enemy to ally/back) – THE WIZARD, TOTO

Aunt Edna

Have great characters in your story, but not too many.

Antagonists

Does your story need a villain or nemesis?

Maybe not, but it does need conflict and tension

Smiling, well-behaved people chilling out doesn’t make an engaging story… SORRY!

Who else is in your story?

Spend sixty seconds, jot down a couple of ideas.

Uncle Frank

Have great details in your story, but not too many.

Add a detail or two to your notes.

Perspective/Time Horizon

• Past tense (creates a sense of credibility)

• Present tense (creates a sense of urgency, and relatability)

• Future tense (inspiring)

What perspective will you use in your story? Make a quick decision…

About the audience

Here are a couple of ideas…

• Relatable protagonist

• Universal emotions - that everyone is likely to identify with, like anger, surprise, disgust, enjoyment, fear, and sadness

• We, us, our, you instead of me, I, they, them

A timeless story

• Wants, needs, and desires (do these change throughout time?) •

Aspirational goals (yearning)

Struggling to achieve something great

Facial expressions, body language (timeless)

Mission, Vision, Values

• Pitch them against one another

• What if following one corporate value places you at odds with another

• A conundrum

• A dilemma

• A choice

• When did following a corporate value save the day?

• When did NOT following a value spoil the day?

7 Story Elements

1. Theme – Stewardship not legacy

2. Plot – Inheriting a business, installing an ESOP, leadership succession

3. Conflict – Management, the bank, disasters

4. Dialog – You can tell when Misty is talking… “honey”

5. Characters – Employees, Management, Family, Friends

6. Setting – Adirondack Dowel Company, Lake Placid

7. World Building – Bicentennial, Olympics, New Wave music, Back to the Future, a Tina Turner concert

1975-1985

Building Blocks

A word

A sentence

A paragraph

A page

A scene + sequel

A chapter

An act

A book

A series

Three little pigs leave home for the big world

The pigs build themselves homes

A wolf passes by the pigs’ homes

Wolf visits straw home of Pig #1

Wolf visits stick home of Pig #2

Wolf visits brick home of Pig #3

Wolf pauses briefly to rethink his plan

Wolf decides to climb up the chimney

Wolf falls down the chimney

Three little pigs enjoy wolf stew

Power VERBS

perch, shimmer, gaze, see, puzzle, whorl, reflect, battle, bob, blink, yawn, ponder, churn, climb, grin, add, create, need, rub, imagine, describe, combine, emphasize, think, sit, hang, banish, rumble, erupt, visualize, ostracize, string, glide, carry, echo

Which are strong?

Which are weak?

Power NOUNS

storyteller, ledge, dawn, cliff, lake, mind, vista, fingers, knot, breeze, hair, head, story, night, twin, world, heads, eyes, children, stomach, sun, sky, narrator, details, saga, things, monsters, hands, demons, expressions, words, audience, fire, descriptions, brother, earth, volcano, tale, sibling, foot, rock, belt, beads, thigh, eagle, water, wings, descendants

Which are strong?

Which are weak?

Sentranced

Verb + Noun

Don’t overuse adverbs and adjectives

The steep, scary, slippery cliff high above the sparkling, blue, shimmering lake was his very favorite place, especially when his mind was troubled.

If you have powerful verbs and nouns, you don’t need adverbs and adjectives to sell your sentence.

…heads bobbed, eyes blinked, and children yawned.

…whenever the earth rumbled, or volcanoes erupted.

Send me your story

• Finish your story

• Email it to me

• I’d love to read it

• Let me know if you’d like my feedback

You can reach me at:

DAVE@ITSOAG.COM

Secret Word for CE

Sluggerrr

David Fitz-Gerald

Historical Fiction Author

Government-backed Funds to Support for Employee Ownership: SBA, SSBCI, States

Steve Storkan

Jack Moriarty

Lars Golumbic

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

State Small Business Credit Initiative

Why Do We Care About the State Small Business Credit Initiative (SSBCI 2.0)?

• Expansion of employee ownership can happen via:

• Conversion of an established business into an employee-owned company

• Creation of a start-up business as worker cooperative

• Acquisition of a business by an employee-owned company

• Expansion/Growth of a current employee-owned company

• The EO community worked diligently to have employee ownership conversions included as an authorized use of SSBCI loan funds. How much will it be used for this purpose?

• We want to ensure that employee-owned companies and their advisors know the SSBCI program details in hopes that significant growth/expansion can occur to create new jobs and new employee owners.

• If we don’t use the funds, will the EO community ever be taken seriously by the federal government?

SSBCI 2.0 - $10 Billion

• $6 billion to States, Territories, and Washington, DC

• $500 million to Tribal Governments

• $1.5 billion to Eligible Governments for business enterprises owned and controlled by Socially and Economically Disadvantaged Individuals (SEDI businesses). This

• $1 billion in additional incentive allocations to Eligible Governments that demonstrate robust support for SEDI businesses.

• $500 million to Eligible Governments for Very Small Businesses (VSBs), (fewer than 10 employees, including independent contractors and sole proprietors).

• $500 million to provide Technical Assistance to certain businesses applying for SSBCI or other government programs that support small businesses.

As of March 8, 2023, forty-eight states and have been approved for SSBCI funding to lend to small businesses for growth and expansion, and 17 states are accepting SSBCI applications through lenders.

• Alaska $60 million

• Arizona - $111 million

• Arkansas - $81 million

• California - $1.1 billion

• Colorado - $105 million

• Connecticut - $119 million

• Delaware - $61 million

• Florida - $488 million

• Georgia - $200 million

• Hawaii - $62 million

• Idaho - $66 million

• Illinois - $355 million

• Indiana – $99 million

• Iowa - $96 million

• Kansas - $69 million

• Kentucky - $117 million

• Louisiana - $113 million

• Maine - $62 million

• Maryland - $198 million

• Massachusetts - $169 million

• Michigan - $237 million

• Minnesota - $97 million

• Missouri - $95 million

• Montana - $61 million

• Nebraska - $64 million

• Nevada - $113 million

• New Hampshire - $61 million

• New Jersey - $225 million

• New Mexico - $74 million

• New York - $501 million

• North Carolina - $201 million

• North Dakota - $59 million

• Ohio - $182 million

• Oklahoma - $82 million

• Oregon - $84 million

• Pennsylvania - $268 million

• Rhode Island - $62 million

• South Carolina - $101 million

• Tennessee - $117 million

• Texas - $472 million

• South Dakota - $62 million

• Utah - $69 million

• Vermont - $58 million

• Virginia - $230 million

• Washington - $163 million

• West Virginia - $72 million

• Wisconsin - $79 million

• Wyoming - $59 million

How can SSBCI funds be used?

• To support small business financing programs and the provision of Technical Assistance to small businesses applying for SSBCI and other government programs

• During SSBCI 1.0 Eligible Governments used SSBCI funds to support the following types of small business financing programs:

• Capital Access

• Collateral Support

• Loan Guarantee

• Loan Participation

• Venture Capital

• During SSBCI 1.0, every dollar of SSBCI capital leveraged $8.95 in new financing, achieving a 8.95:1 leverage ratio. A leverage ratio of 10:1 has been set for SSBCI 2.0

How can SSBCI funds be used?

• Must be used for an eligible business purpose which includes, but is not limited to

• startup costs, working capital, business procurement, franchise fees, equipment, inventory, as well as the purchase, construction renovation or tenant improvements of an eligible place of business that is not for passive real estate investment purposes.

• excludes acquiring or holding passive investments such as commercial real estate ownership, or the purchase of securities; and lobbying activities

• Ineligible uses:

• repayment of a delinquent federal or state income taxes

• repayment of taxes held in trust or escrow, e.g. payroll or sales taxes

• reimbursement of funds owed to any owner, including any equity injection or injection of capital for the business’ continuance;

• purchase of any portion of the ownership interest of any owner of the business.

• cannot be used to purchase ownership interest of any owner of the business EXCEPT:

• For the purchase of an interest in an employee stock ownership plan, worker cooperative, or related vehicle. The transaction must result in the employee stock ownership plan or other employee-owned entity holding a majority interest (on a fully diluted basis) in the business.

** The Treasury department has confirmed that this provision allows current ESOP owned companies (regardless of percent ESOP owned to use SSBCI funds for the acquisition of 100% of another company

Program Examples

• Capital Access Programs (CAPs)

• Provides portfolio insurance via a loan loss reserve to lenders who are financial intuitions that that make small business loans

• Borrower must have 500 employees or less at the time of the loan

• Loan cannot exceed $5 million and must go toward an “eligible business purpose”

• Other Credit Support Programs – (OSCPs)

• Lenders and investors not required to be financial institutions

• Borrower must have 750 employees or less

• Transaction may not exceed $20 million

Types of OSCPs

• Venture Capital – public private partnerships for equity investing or VC funds

• Loan Guarantee – assures lenders will be partially repaid in event of default

• Loan Participation – states buy interest in loans or lend along side

• Collateral Support – set asides funds used for collateral for start-ups

THE MINNESOTA LOAN GUARANTEE PROGRAM (MNLGP)

• Provides guarantees to enrolled lenders for up to 80% of principal on loans to eligible businesses with less than 750 employees (preferred to be less than 500)

• Targeted Loan Amount up to $5 million (can be as high as $20 million). Maximum loan guarantee amount is $800,000..

• A fee 0.25 percent of the guaranteed amount is charged for each enrolled loan.

• Waived for loans to qualified Socially and Economically Disadvantaged Individuals (SEDI)-Owned businesses

• Borrowers must be Minnesota-headquartered businesses using the loan proceeds for an eligible business purpose in Minnesota.

• Eligible business purposes include startup costs, working capital, equipment, inventory, the purchase, construction, renovation, or tenant improvements of an eligible place of business that is not for passive real estate investment purposes, and the purchase any tangible or intangible assets except goodwill.

• Loans and lending decisions are made by enrolled lenders – no loans come directly from DEED. The guarantee is provided to the lender to help mitigate risk.

MINNESOTA AUTOMATION LOAN PARTICIPATION PROGRAM (ALPP)

• Makes companion loans intended to fill gap financing needs for businesses purchasing machinery, equipment, or software to increase productivity and automation.

• Loans need to be made in conjunction with private financing, typically a bank, in an amount at least equal to the DEED loan.

• Loans may be up to $500,000 with 1% interest on a 5 to 7-year term.

• Eligible borrowers include manufacturing, distribution, technology and warehousing businesses located in Minnesota. The program targets businesses with fewer than 500 employees.

THE MICHIGAN COLATTERAL SUPPORT PROGRAM

• Created to address collateral shortfalls that would otherwise not allow a lender to provide new financing to a small business operating in Michigan with less than 750 employees

• Provides cash collateral to enhance the collateral coverage of a borrower by depositing cash into an interest-bearing account with the lender.

• The cash account will then be pledged as collateral on behalf of the borrower. In the event of full default, the lender will have rights to the account less a liquidation fee.

• For loans totaling $500,000 or less, a borrower is generally eligible regardless of industry in which it operates. For loans totaling $500,001 or more, a borrower must operate primarily in one or more of the following industries: mobility, manufacturing, professional and corporate services, medical device technology, engineering, design and development, high tech, agribusiness, tourism, logistics, and financial services.

• The maximum participation is capped at $5,000,000 and may not be used to support individual extensions of commercial credit of greater than $20,000,000.

MICHIGAN BUSINESS GROWTH FUND LOAN PARTICIPATION PROGRAM

• Created to finance projects for borrowers whose projected cash flows are considered speculative by the lender or where the lender is seeking a noncompetitive participant due to a legal lending limit or portfolio concentration concern

• The MBGF–LPP will purchase a portion of a loan from the lender and can offer a grace period on the program’s portion of the loan for up to 36 months.

• It limits the project exposure of lenders and offers borrowers “free cash flow” during the grace period allowing full coverage on the lender’s portion of the loan. Enables borrowers to acquire the needed financing.

• Borrower must have no more than 750 employees and working with a private lender for the purpose of acquiring a commercial extension of commercial credit.

• The maximum participation is capped at $5,000,000 and may not be used to support individual extensions of commercial credit of greater than $20,000,000.

Socially and Economically Disadvantaged Individuals Business (SEDI Business)

Option A - A business enterprise that certifies that it is owned and controlled by individuals who have had their access to credit on reasonable terms diminished compared to others incomparable economic circumstances, due to

(1) membership of a group that has been subjected to racial or ethnic prejudice or cultural bias within American society, (2) gender, (3) veteran status, (4) limited English proficiency,

(5) disability, (6) long-term residence in an environment isolated from the mainstream of American society, (7) membership of a Federally or state-recognized Indian Tribe,

(8) long-term residence in a rural community, (9) residence in a U.S. territory

(10) residence in a community undergoing economic transitions (including communities impacted by the shift towards a net-zero economy or deindustrialization)

(11) membership of an underserved community. (Underserved communities are populations sharing a particular characteristic, as well as geographic communities, that have been systematically denied a full opportunity to participate in aspects of economic, social, and civic life, as exemplified by the list in the definition of equity. Equity is consistent and systematic fair, just, and impartial treatment of all individuals, including individuals who belong to underserved communities that have been denied such treatment, such as Black, Latino, and Indigenous and Native American persons, Asian Americans and Pacific Islanders and other persons of color; members of religious minorities; lesbian, gay, bisexual, transgender, and queer (LGBTQ+) persons; persons with disabilities; persons who live in rural areas; and persons otherwise adversely affected by persistent poverty or inequality.);

Socially and Economically Disadvantaged Individuals Business (SEDI Business)

Option B – A business enterprise that certifies that it is owned and controlled by individuals whose residences are in Community Development Financial Institution (CDFI) Investment Areas, as defined in 12 C.F.R. § 1805.201(b)(3)(ii)

Option C – A business enterprise that certifies that it will build, open, or operate a location in a CDFI Investment Area, as defined in 12 C.F.R. § 1805.201(b)(3)(ii)

Option D – A business enterprise that certifies that it is located in a CDFI Investment Area, as defined in 12 C.F.R. § 1805.201(b)(3)(ii).

CDFI Investment Area Mapping Tool - https://cimsprodprep.cdfifund.gov/CIMS4/apps/pncdfi/index.aspx

How can SSBCI Technical Assistance Funds (TA Funds) be used?

• SBCI provides that $500 million may be used to provide Technical Assistance to certain businesses applying for SSBCI or other state or federal programs that support small businesses

• Any funds used for TA must be directly tied to use of Capital Funds (Cap Funds).

“Funds provided under a TA Grant Program award are for the provision of legal, accounting, and financial advisory services intended to help SEDI-owned businesses and Very Small Businesses (10 or less) access SSBCI capital or participate in other federal or other jurisdiction programs that support small businesses.

✔ Legal Services includes – “Legal services related to a transfer of ownership interests in a business, in the case of employee stock ownership plans (ESOPs)

• Creates an Employee Ownership and Participation Initiative within the Department of Labor’s Employment and Training Administration (ETA)

• DOL ETA is authorized to make grants totaling $50 million over 5 years for the following activities:

• Education and outreach

• Participation training

• Technical assistance, including prefeasibility studies, and support for the carrying out of thirdparty feasibility studies and preliminary business valuations; and

• Activities facilitating cooperation among employee ownership firms.

• Total Grant Amount/Maximum grant amount per grantee:

• $4 million/$300,000 per grantee in Fiscal Year 2025 – (funds 13 entities with max grants)

• $7 million/$330,000 per grantee in Fiscal Year 2026 – (funds 21 entities with max grants)

• $10 million/$363,000 per grantee in Fiscal Year 2027 – (funds 27 entities with max grants)

• $13 million/$399,300 per grantee in Fiscal Year 2028 – (funds 32 entities with max grants)

• $16 million/$439,200 per grantee in Fiscal Year 2029 – (funds 36 entities with max grants)

WORK Act (Continued)

• Section 346(c)(4)(B) of the WORK Act compels the DOL to develop “acceptable standards and procedures to establish good faith fair market value for shares of a business to be acquired by an employee stock ownership plan.”

• Congressional mandate to issue regulation defining “adequate consideration” under section 3(18) of ERISA.

• Procedural safeguards under Administrative Procedure Act, i.e. final regulation following a noticeand-comment process with input from stakeholder community

State Level Employee Ownership Legislation

States with Legislation

Introduced or Passed

Common Elements of Legislation

New EO Transactions

California – EO office

Colorado – Many pro EO elements

Iowa – Feasibility/Tech. Assistance

Massachusetts – EO Office

Minnesota – tax break (proposed)

Missouri – tax break

New York – professional service corp. EO

Pennsylvania – many elements (proposed)

Tennessee – tax break (proposed)

Texas – preferential treatment (proposed)

Washington – many elements (proposed)

** Tax Breaks – selling shareholders, companies, and lenders

** Technical Assistance/Feasibility Studies – grants or tax credits

** Creation of EO Office in State Government

** Funding for Outreach & Education – non-profit organizations

** Easier Access to Capital – loans and loan guarantees

** Keep Minority/Women Owned Business (MWBE) Status

Current EO Companies

** Preferential Treatment – similar to MWBE

** Access to Capital for Expansion - loans and loan guarantees

Employee Equity Investment Act (EEIA)

Legislative Overview

Why Don’t We See More ESOPs?

A key barrier standing in the way of further adoption of employee ownership in the United States is a financing gap

Financing ESOPs: The Capital Gap

⮚ Prospective employee owners generally have limited to no equity capital to initiate their purchase of the selling business owner’s interests

⮚ Traditional ESOP transactions are generally dependent upon a combination of:

⮚

⮚

1) bank leverage using company assets as collateral and

2) sellers taking back substantial subordinated, long-term notes (60% -75% of the transaction) – prohibitive terms for most sellers

⮚ EEIA would resolve this financing problem by replacing seller debt with structured equity (subordinated notes + warrants) from licensed Employee Equity SBIC funds, thereby these funds to structure competitive transactions for the fair market value of the business.

Employee Equity Investment Act (EEIA)

⮚ Start to close the yawning M&A gap between sales to financial/strategic buyers and sales to employees

❑ US annual M&A market: 17,000+ businesses

❑ US annual ESOP transactions: 150 businesses

⮚ Remove barriers for existing women & minority-owned businesses to become employee-owned

⮚ Desired effects:

✔ Create and retain high-quality jobs

✔ Reduce wealth and geographic inequality

✔ Build a competitive and more resilient business sector and labor market

✔ Build the assets of low and moderate-income workers including workers of color

✔ Reduce corporate consolidation

✔ Reduce offshoring and preserve domestic productive capabilities

⮚ Accomplish all of this at zero subsidy cost to the taxpayer by mobilizing private investment

EEIA Bipartisan Sponsors

Rep. Blake Moore (R-UT) Rep. Dusty Johnson (R-SD)

Rep. Dean Phillips (D-MN) Rep. Chrissy Houlahan (D-PA)

Sen. Chris Van Hollen (D-MD) Sen. Marco Rubio (R-FL)

How EEIA Sponsors Invest in ESOPs

• Banks provide secured debt and mezzanine funds or sellers provide unsecured debt to establish or refinance ESOPs

• EEIA Sponsor’s “Structured Equity” investment comes in the form of an ESOP Note and Warrants

SECURED Debt (Revolver / Senior Term / Term B)

Investment in Subordinated debt

UNSECURED Debt (Mezzanine / EEIA Note)

EEIA Sponsor’s Warrants (minority of EV by law)

EEIA Policy Design

Fund Size + Leverage Ratio Comparison

⮚ $5B annual credit authorization (zero subsidy, not an appropriation)

⮚ New cohort of licensed Employee Equity SBIC funds

⮚ Invest “structured equity” in new and existing employee-owned businesses

⮚ Business eligibility up to 300% size standards

⮚ Women & minority-owned businesses no longer lose certification after sale to employees

⮚ New SBA Office

Ownership

Results: EEIA Sponsor $ Invested by Year

• The model projects the following investment by EEIA sponsors, per year, in ESOP companies:

Results: Number of ESOP Participants Created

• The model projects the following Cumulative number of new ESOP Participants created over time:

Results: Value per ESOP Participant

• The model projects that after 20 years of being an ESOP company, the average employee will have an Allocated Account Balance of $450,000

Results: Value of All EEIA Sponsored ESOP Shares

• The model projects the following EEIA related total ESOP Benefit value created over time, growing to about $440 Billion of ESOP value by Year 20

Results: Comparison of ESOP Value to PE Sponsor Value (for a Single ESOP Company)

• Chart compares one ESOP’s Value vs the PE Sponsor’s value

– The ESOP’s Value includes (1) Shares held, plus (2) Cash for Shares Put

– The Sponsor Value includes (1) Principal and Interest, plus (2) Warrants held (in-themoney value and final payments)

• ESOP is always better off vs PE firm, and employees put No Money at risk

Results: Number of Potential New Jobs Created

• IF ESOP companies grow 2.3% faster, then the EEIA program would ALSO create NEW JOBS as these ESOP companies grow faster than they otherwise would.

Summary of Results

• The EEIA program could achieve the following goals for US workers and their families and communities:

– Create over 2.4 million new employee owners by Year 20

– $450,000 Average employee account balance after 20 years of being an ESOP

– Over $440 Billion of new ESOP value in company stock by Year 20

– Almost 590,000 new jobs created IF the EEIA sponsored ESOP companies grow 2.3% faster than non-ESOP companies (as suggested by research).

– ESOP always reaps a majority of value (versus the EEIA PE Sponsor), and puts No Employee money into the Transaction

Secret Word for CE

Bo Jackson

High Performance Leadership Teams as the Foundation of Employee Ownership Culture

Heather Icke, Apex Plumbing

Melissa Hoover, DAWI

Melisa Gillis, Gillis Consulting

Michael Quarrey, Web Industries

CE Requirements - Onsite

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

4. Input the instructor give secret word into your survey

Two Decades of High-Performance Leadership Teamwork

Secret Word Harrison Butker

How to Grow Old as an ESOP:

Governance, Plan Design & Administration

John Burgess

Jackson Lewis PC Curtis Schehr

DCS Corporation

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

The challenges that a more mature ESOP face are much different from those of a younger ESOP. Still, younger ESOPs should be thinking about the challenges that they’ll have down the road. The most common issues include:

• Repurchase Obligation

• Haves vs. Have-Nots Problem

• Corporate Governance

• Communications •

Executive Succession Planning

Repurchase Obligation

• When mature ESOP companies start to run into financial problems, it’s frequently due to a failure to plan for the ESOP Repurchase Obligation

•

“Repurchase Obligation” is the requirement for the ESOP and/or the company to buy back the vested shares of terminated participants

• As the share price grows, the higher the Repurchase Obligation gets, and share price will start to grow rapidly as the outside debt that was taken on in the ESOP transaction is paid down

Repurchase Obligation

• The Repurchase Obligation can be controlled and planned for a few different ways:

• Effective use of a distribution policy

• Take advantage of cash-outs of small accounts (remember, this limit goes up to $7,000 starting next year)

• Redemptions, reshuffling and rebalancing accounts (more on that later)

• Typically, the company wants to keep yearly distribution obligations as consistent as possible from year to year – avoiding large obligations in one year is important

Repurchase Obligation

• A Repurchase Obligation study can help in planning – it takes into consideration things like:

• Current and future allocations of shares

• Expected values of shares

• Vesting schedules

• Expected rates of retirement and terminations of participants

• Upcoming diversification elections

• A study should be done every 3 or 4 years – and some trustees require it

Haves vs. Have-Nots Problem

• When an ESOP starts, there are plenty of shares to go around when it’s time to allocate them each year

• Although some employees will forfeit shares or they will be repurchased after termination, mature ESOPs sometimes run into issues in getting enough shares into the hands of new participants

• If new employees aren’t getting the shares they should get, it can hurt the ESOP culture or make the ESOP less valuable to them

Haves vs. Have-Nots Problem

•

In the ESOP world, we frequently refer to this as the “haves vs. have-nots problem”

• There are a number of potential solutions to this problem, and which one works for a particular company will depend on its circumstances

• Sometimes, it requires a combination of several different approaches – but figuring out the best way to do it requires professional help!

• In the next few slides, we’ll go over some ideas

Haves vs. Have-Nots Problem

• Recycling: Instead of retiring shares bought out from terminated participants, those shares stay in the ESOP and allocated again

• The extent to which this is going to be effective is going to depend on how many shares can be bought out and put back into the plan, so it may not be enough for a company with low turnover

Haves vs. Have-Nots Problem

• Rebalancing: The trustee allocates stock and cash inside the plan so that each individual account has an equal percentage of cash and stock

• This results in moving shares out of the accounts of longerterm participants into those of newer participants, although all employees are still getting allocations of new shares

• The downside is that this takes shares out of the accounts of longtime participants, so you don’t want it to be a significant portion of their balance

Haves vs. Have-Nots Problem

• Reshuffling: This is transferring accounts of terminated ESOP participants out of stock and into cash investments, freeing up the shares to be allocated to active employees

• This also results in terminated participants not being able to continue to enjoy future appreciation of the stock when they no longer work there

• It can also be used to manage repurchase liability

• You don’t have to reshuffle all of a participant’s account, but you can’t discriminate in favor of HCEs

Haves vs. Have-Nots Problem

• Releveraging: After the company redeems shares from terminated participants, the trustee re-acquires the shares using a new “inside” note that can be structured to release the shares over a term that gets shares into accounts of all eligible participants:

• Because these shares are allocated over a number of years, you need a critical mass of shares to make this work

• Since this is just an inside note, the purchase price can be set low so that it won’t cause a fiduciary concerns

Haves vs. Have-Nots Problem

• Early or Enhanced Diversification: If participants are given the opportunity to diversify their account before legally required (age 55 with 10 years of participation), or can diversify more than the amount legally required, some participants may take advantage and this can free up additional shares for new participants

• Of course, there are no guarantees because participants ultimately decide whether or not to take advantage

Corporate Governance

• When an ESOP is formed, the selling shareholder(s) frequently maintains a very active role for several more years and continue to control governance with the input of the ESOP trustee

• As the selling shareholder(s) starts to step away, the company needs to be more focused on functioning less like a family business

• This usually means an independent board of directors

Corporate Governance

• The ESOP trustee – as the shareholder – elects the Board, so the trustee should be involved in recruiting and selecting new Board members

• There are plenty of other sessions that deal with how to select great independent directors, but it’s best to plan for this and recruit them ahead of time • Great idea from DCS: have one Board seat (out of 7) reserved for a non-executive employee-owner

Communications

• ESOP Communications Committee Attributes

• Members may be determined by geography or other criteria

• Committee members plan and manage communications and events

• Communication items may include a monthly newsletter

• Committee may feature webinars on ESOP topics such as contributions, valuation, diversification and distribution

• Committee may sponsor community engagement activities such as a book drive or charity walk-a-thon

• Sponsor other activities such as annual ESOP poster contest

• winning poster is submitted as entry to the ESOP Association's national poster contest

Executive Succession Planning

• Executive Succession Planning (ESP) supports continued growth and success through a structured and carefully managed process to identify and develop internal and external candidates to succeed incumbent company executives

• ESP will also help ensure thoughtful transitions when unforeseen senior executive departures arise and immediate action is required.

Executive Succession Planning

Process:

• Board committee oversees executive succession planning

• May be assigned to Nominating & Corporate Governance Committee or a separate Executive Succession Committee

• Consider preparing a charter (mission statement) for this effort

• Determine the level of executives to which this process will apply (at DCS, applies to Executive VPs, COO and CEO)

• Committee members should ideally include a majority of outside directors

• Engagement of an outside consultant may be helpful, particularly if several executives will be exiting in similar timeframe

Executive Succession Planning

• Consider two broad categories of executive succession planning:

• Category 1 –Emergency Plan

• Sudden, unexpected unavailability of executive, whether due to resignation, illness or death

• Emergency Plan identifies, to the extent feasible, the individual who would temporarily assume the responsibilities of the vacant position

• Temporarily appointed individual will be assessed by executive management and the board committee to determine long-term suitability for the position

• External candidates may be identified and considered if appropriate

• CEO and committee chair maintain emergency succession specifics

• Emergency succession details reviewed whenever there is a change involving an identified “back-up” or other developments occur

Executive Succession Planning

Category 2 – Planned Executive Succession

• Begins with CEO (or another executive appointed by CEO for this purpose) periodically querying covered executives regarding retirement or other plans in the next 2-3 years

• CEO identifies potential internal candidates for the position(s) expected to be vacated

• External candidates may also be considered if desired

• CEO informs the board committee with responsibility for oversight of executive succession

Executive Succession Planning

Category 2 – Planned Executive Succession

• Individual Development Plans (IDPs) are created for internal candidates which may include some or all of the following elements:

⮚ Mentoring (internal)

⮚ Coaching (external)

⮚ Classroom or online training

⮚ Challenge assignments

⮚ Position rotation

⮚ Leadership engagement

• Other tools such as 360 reviews and personality assessments (e.g., Hogan) may be used

Executive Succession Planning

• Oversight committee meets with CEO on a quarterly basis to review progress being made toward filling an identified executive position.

• Committee review will include, where appropriate, internal candidate progress against individual development plans and/or progress toward finding external candidates.

• Board committee will also review incumbent transition plans to assure schedules make sense when compared to the development progress being made by internal succession candidates. Where candidates for succession are external, schedules will be assessed based on progress being made during the interview process

• Once selection of a successor is firm, the incumbent executive develops a transition plan which is reviewed by the board committee

• Incumbent executive may be asked to brief the oversight committee on transition progress if requested by CEO

Executive Succession Planning

Additional Planning Recommendations:

• Develop position descriptions for each “covered” executive

• Develop a list of qualities and characteristics desired for all covered executives such as:

• Effective Communication

• Leadership

• Strategic Thinking

• Inclusive Problem Solving

• Market/business environment understanding

• Business acumen

• Promotes brand and core values

• Coaches and collaborates to develop personnel

Executive Succession Planning

Identify Positions & Criteria

Identify Candidates

Assess: Now & Potential Development Track Progress

Executive Succession Planning

• CEO’s commitment is absolutely essential

• Board leadership, visibility, and involvement is essential

• 2 to 3+ year succession planning horizon – takes time

• Start with identifying future leadership needs and capabilities

• Outside director involvement can add legitimacy, perspective and independence

• Strategy drives succession planning

• CEO succession planning sets the tone for succession planning and leadership development for the entire company

• CEO annual performance assessment includes succession planning criteria

Executive Succession Planning

• Once elements of the executive succession plan are fairly established in practice, prepare a written description for future reference

• Review and update plan as the process matures

Secret Word for CE

Rosedale Park

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

AGENDA

About ProfitWorks

The Three Fundamental Disciplines

Operating System

The No-Entitlement Incentive Plan®

Communication (The Missing LinkTM)

Q&A

About Us

Power of Positive TENSION

Motivation is Highest When Success Probability = 50%

ENTITLEMENT/ APATHY

EARNING / FLOW

FEAR / ANXIETY

Moving From ME To WE

OWNER

Cash Flow

Risk

Revenue Growth

Market Share

Economy

Employee Retention

Cost Control

EMPLOYEE

Paycheck

Benefits

Recognition

Job Security

Friday

Work Environment Opportunities

IT’S NOT US VS THEM- IT’S WE!

OPERATING SYSTEM

▪ Clear Vision

▪ Execution & Accountability

▪ Healthy Culture

THE MISSING LINKף

▪ Profit Education

▪ Tension Tools®

▪ Meeting Discipline

THE NO- ENTITLEMENT INCENTIVE PLAN®

▪ Establish Trigger

▪ Determine Share

▪ Decide Who

Right PEOPLE

OPERATING SYSTEM

▪ Clear Vision

▪ Execution & Accountability

▪ Healthy Culture

THE MISSING LINKף

▪ Profit Education

▪ Tension Tools®

▪ Meeting Discipline

THE NO- ENTITLEMENT INCENTIVE PLAN®

▪ Establish Trigger

▪ Determine Share

▪ Decide Who

Q. A.

WHAT’S THE PURPOSE OF AN INCENTIVE PLAN?

The primary purpose of an incentive plan is to shape employee behavior toward improving the financial performance of the company.

Incentive Plan MISTAKES

The NO-ENTITLEMENT Incentive Plan®

SIMPLE: Simple in design, easy to explain, understand, and trust.

KEY DESIGN ELEMENTS

SELF-FUNDED: Drives the value of the business

SHARED TARGETS: One company, one voice

POSITIVE TENSION: A stretch, but attainable

SHAPES BEHAVIOR: Alignment toward business goals

MOTIVATING: Perceived as valuable

The 10 QUESTIONS For Your Plan

1. Profit trigger?

2. % share of incremental profits?

3. Stretch goal?

4. Who will participate / eligibility?

5. # of employees?

6. Total Payroll $?

7. % of Wages, or Equal payout?

8. Cap or no cap?

9. Payout frequency?

10. Leadership Team pool?

Incentive Plan DESIGN

40% of incremental PBT dollars after trigger of $300,000 go to incentive plan.

At stretch goal PBT of $650,000 payout is 10% of total wages.

Cap on plan - No

Separate Leadership team pool - Yes

OPERATING SYSTEM

▪ Clear Vision

▪ Execution & Accountability

▪ Healthy Culture

THE MISSING LINKף

▪ Profit Education

▪ Tension Tools®

▪ Meeting Discipline

THE NO- ENTITLEMENT INCENTIVE PLAN®

▪ Establish Trigger

▪ Determine Share

▪ Decide Who

Profit EDUCATION (Why Bother?)

What Your Employees

Don’t Know Can Hurt You

TRANSPARENCY Continuum

Blank Income Statement EXERCISE

GROSS PROFIT

OPERATING EXPENSES

NET PROFIT (BEFORE TAX)

Everyone Can Create PROFIT SALES

Show Me The MONEY Exercise

List inefficiencies and missed opportunities.

Where are the holes in the Pail?

CHALLENGE Rocks Examples

QTR NAME OBJECTIVE

Q1 The Vendor Love Boat Reduce junk fees; take all discounts

Q1 Sizzlin Samples Reduce sample expense and sample freight

Q1 Mercedes Drives 100 Add 100 new accounts per month

Q1 Returns of The Jedi Reducing Customer Returns

Q1 It Ain't Easy Being Green Reducing Carbon Footprint

Q2 CPR Flatliners Reduce Customer Attrition

Q2 The Terminator Paperless picking and packing in Warehouse

Q2 Deal Or No Deal Reduce various operating expenses

Q2 Up (A Catalog Adventure) Obtain vendor sponsorship for ads in catalog

Q2 Credit Casino Royale Reduce customer credits due to order error

$223,710

Q3 The Matrix Increase Web sales

Q3 No Going Postal Invoice via fax or email–reduce postage

Q3 The Three Amigas Upselling customers during order taking

CHALLENGE Rock Examples

QR CODE LINK TO MATRIX VIDEO

OPERATING SYSTEM

▪ Clear Vision

▪ Execution & Accountability

▪ Healthy Culture

THE MISSING LINKף

▪ Profit Education

▪ Tension Tools®

▪ Meeting Discipline

THE NO- ENTITLEMENT INCENTIVE PLAN®

▪ Establish Trigger

▪ Determine Share

▪ Decide Who & Payout Timing

Two FINAL Thoughts

Moving from Entitlement to Earning is a cultural transformation. It takes commitment, practice and time.

Whether you believe your employees can understand this, or you believe they can’t, you’re right.

Journey to 100% S ESOP

Christel Jimenez, Principal® Vice President Consulting

B. David Joffe, Bradley Partner

Stephen A. Martin, Argent Trust Senior Vice President, Senior Fiduciary Consultant

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

Journey to a 100% S ESOP

Christel Jimenez, Principal ® Vice President Consulting

Christel is a Sales Consultant with over 13 years of experience with ESOPs from within the industry and as an officer of an ESOP-owned company. She has extensive knowledge and experience in recordkeeping, ERISA plan compliance and complex ESOP issues.

She is an active member of The ESOP Association (TEA), the National Center for Employee Ownership (NCEO) and Employee-Owned S Corporations of America (ESCA). She is a frequent conference speaker.

Christel earned a BS in Finance from The Pennsylvania State University and a Master of Business Administration from Central Michigan University.

Journey to a 100% S ESOP

David Joffe practices primarily in the areas of employee benefits and executive compensation law. He has advised clients for over 30 years on complex issues relating to employee benefits and executive compensation. David regularly assists clients with the design, implementation, and administration of retirement, welfare, and executive compensation plans. He also counsels employers and executive management on benefits and executive compensation issues.

David has experience representing public and private employers ranging in size from small businesses and professional corporations to large service corporations, governmental entities, manufacturing facilities, and hospital systems. A particular focus of his practice is employee stock ownership plans. David is the chair of the Employee Benefits and Executive Compensation Practice Group at Bradley.

B. David Joffe, Bradley Partner

Journey to a 100% S ESOP

Stephen A. Martin, Argent Trust Senior Vice President, Senior Fiduciary Consultant

In 2006, Steve Martin joined Reliance Trust Company and his former colleagues from C&S/Sovran Trust Company to rebuild the fiduciary services business at Reliance. While at C&S, Steve managed many of the most complex ESOP relationships and master trust clients of the firm.

With over 35 years of employee benefit and trust administration experience, Steve’s accomplishments include managing institutional sales and relationship management at Wachovia, SunGard and US Trust. While at Invesco Retirement Services, Steve developed Invesco’s successful strategic partnership business for retirement services outsourcing. Steve is a graduate of the University of Georgia and holds a Bachelor of Business Administration in Accounting. He also has held NASD Series 7,6 and 63 Securities licenses. Steve is a frequent speaker on fiduciary topics and is a member of The ESOP Association and NCEO.

Journey to a 100% S ESOP

Matt Ryan, S&ME, Inc. President and CEO

S&ME's President and Chief Executive Officer Matt Ryan is a known champion of the A/E/C industry. He built his 30-year career in both the public and private sectors to drive the engineering and construction industries, and amassed a knowledge and understanding of the people, services, and technologies that deliver solutions. Matt is laser-focused on client delivery. As president and chief executive officer, he is responsible for the leadership, direction, and management of the organization. Matt came to S&ME four years ago with a fervor to lead this 1,100-person employee-owned company after having spent 18 years with an 11,000-person 100% employee-owned company.

In late 2020 and early 2021, Matt led the conversion of S&ME to a 100% ESOP company. Employee-ownership is core to Matt’s “DNA.” He was raised in a small, family-owned mechanical firm that his younger brother leads today. Along his life’s journey, Matt learned that company culture is paramount; it's what keeps our staff motivated and productive and our clients satisfied. A graduate of George Mason University, Matt has an MBA and a BS in finance. His experience ranges from project management to business development to executive leadership in small to mega engineering firms.

Step 1: Decide on Your Destination

• Diversify shareholder’s wealth

• Retain exposure to future upside

• Less debt needed by company compared to 100% ESOP

• Multiple stock classes permitted

• Defer or eliminate capital gains taxes under 1042

• ESOP tax shield limited to ESOP contributions

• Diversify shareholder’s wealth

• Retain exposure to future upside

• Less debt needed by company compared to 100% ESOP

• Single class of stock permitted

• ESOP-owned portion of earnings exempt from federal and most state income taxes

• Subject to 409(p)

100%

• Earnings exempt from federal and most state income taxes

• Provide liquidity to sellers nearing retirement or other life event

• Provide a source of additional shares/benefit for new and current plan participants

• Stable ownership strategy

• Subject to 409(p)

Partial S Corporation ESOP

S Corporation ESOP

Partial C Corporation ESOP

Step 1: Decide on Your Destination

Tax Efficiencies Increase Cash Increase Shareholder Value

Enhanced Financial Flexibility & Predictability

Goal

Establish a Balanced Ownership Structure

100% Employee Owned Company

Step 2: Choose Your Route

Ongoing stock contributions

Sale to ESOP

Share redemption

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route

Ongoing stock contributions

Sale to ESOP

Share redemption

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route

Ongoing Stock Contributions to the ESOP Considerations

• Typically, company purchases shares from seller(s) and contributes them in kind to the ESOP

• Provides company and seller(s) considerable flexibility over timeline

• Generally does not have dilutive impact on share price

• Contributions are tax-deductible

Step 2: Choose Your Route

Ongoing stock contributions

Sale to ESOP

Share redemption

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route Sale to ESOP

Step 2: Choose Your Route Sale

to ESOP

Considerations

• Selling shareholders may qualify for 1042

• ESOP typically borrows funds to finance the transaction

• Participants will likely see a drop in share value due to debt associated with the transaction

• Trustee may want to negotiate price protection

Step 2: Choose Your Route

Ongoing stock contributions

Sale to ESOP

Share redemption

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route Share Redemption

Company sells shares to ESOP in exchange for note

Step 2: Choose Your Route Share Redemption

Considerations

• Shares held by direct owners are purchased by company in exchange for cash/seller note/combination of both

• Selling shareholders will not qualify for 1042

• Company typically borrows funds and/or executes seller notes to finance the transaction

• Redemption may avoid the post-transaction drop in share price

Step 2: Choose Your Route

Ongoing stock contributions

Sale to ESOP

Share redemption

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route

Sale/Redemption with Lateral Transfer

Step 2: Choose Your Route

Sale/Redemption with Lateral Transfer Considerations

• Can provide direct shareholders a method of replicating their ownership under the ESOP

• Provides another funding source to help finance the transaction

• Disclosure requirements/antifraud/blue sky law considerations

• Employee communication

• Cost and complexity of transaction

Step 3: Pick Your Passengers

Assembling Your Transaction Team

• Trustee

• Trustee’s Counsel

• Valuation Firm

• Seller/Company Counsel

Seller/Company Advisors

Lender

Recordkeeper

• CPA

Step 4: Tune Up & Maintenance

Company

• Manage cultural shift to a 100% employee-owned company

• Succession planning

• Management incentive programs

• Analyze impact to company financials

• Analyze change in cash flow as result of transaction

• Forecast change to repurchase liability

• Corporate governance changes

• Valuation changes

• Compliance considerations

Step 4: Tune Up & Maintenance

Trustee

• Act solely in the best interests of the participants

• Typically votes shares to elect directors

• Monitors financial performance

• Determines the Fair Market Value of the stock

• Represents the interest of the ESOP

• Understand the transaction as a whole

• Conduct due diligence

• Legal

• Financial

• Fiduciary

Step 4: Tune Up & Maintenance

Trustee

• Conduct interviews with management

• Review corporate governance

• Negotiate with seller

• Analyze value of company

• Review and approve transaction terms & documentation

• Stock purchase/redemption agreement

• Disclosure memorandum, if applicable

• Loan documents

• Management incentive plans

Step 4: Tune Up & Maintenance

Company’s Legal Counsel

• Prepare letter of intent/terms sheet

• Review transaction engagement agreements (trustee, trustee counsel, trustee financial advisor)

• Draft ESOP plan documents

• Review bank financing documents

• Prepare closing checklist and transaction documents

Step 4: Tune Up & Maintenance Company’s Legal Counsel

• Draft management incentive plan

• Assist on pre-closing matters (e.g., articles/bylaws/minutes, stock splits, shareholder agreements, leases/title, insurance, IP filings, environmental issues, governmental authorizations, third party consents)

• Manage closing

• Post-closing matters (e.g., working capital adjustment, escrows, stock ledger, file Form 5300

Step 4: Tune Up & Maintenance

Trustee’s Legal Counsel

• Conduct due diligence review

• Typically prepare due diligence memorandum for trustee

• Typically attend trustee committee meetings

• Review and comment on transaction committee meetings

• Advise trustee on fiduciary obligations (process agreements)

• Post-closing matters (e.g., working capital adjustment, escrows)

Step 5: Off We Go!

Timeline is for illustrative purposes only.

S&ME’s Journey to a 100% S ESOP

S&ME’s Journey to a 100% S ESOP

Who We Are: Engineers, Scientists, & Construction Services

Professionals

• Privately-held, 100% employee-owned, S Corp

• 1,100 employee-owners

• 10 States, 30+ Offices

• 50-year anniversary in 2023

S&ME’s Journey to a 100% S ESOP

Beginning state: Partially-owned C Corporation ESOP with 200+ direct shareholders.

79% ESOP. 21% direct ownership by employees. Direct owners selling stock at 4:1 (sellers/buyers) in dollars. ESOP Trustees were four inside members (i.e., employees) of the Board of Directors.

Destination: 100% ESOP, S Corporation. ESOP Trustee and Valuation firms are 3 rd party. Migrate to another Third-Party Administrator (TPA) for ESOP and 401(k).

Route: Redemption with Lateral Transfer

S&ME’s Journey to a 100% S ESOP

Objective: To develop a feverish employee-owned culture to drive S&ME’s strategic plan

1. Broad-based employee ownership; expanded the pool of ownership so all current employees can buy company stock

2. Expanded the capital base by giving employees the ability to use 401(k) savings to buy company stock at their discretion

3. Realizing the tax benefits to S&ME by converting from a C corporation to an S corporation

4. Transitioning to a single class of ownership in the ESOP

S&ME’s Journey to a 100% S ESOP

S&ME’s map consisted of four major elements:

1. Corporate redemption of all current shareholders

2. Opportunity for employees to voluntarily elect to transfer funds from the 401(k) plan to the ESOP, to be invested in S&ME stock

3. Convert from a C corporation to an S corporation

4. Management incentive program to retain and motivate key talent

S&ME’s Journey to a 100% S ESOP

Employee Communication Strategy

• Incremental education campaign

• Involve employees to participate in developing and implementing

• Live, hands-on training about “Own It” and for the Principal® web site

• Establish Share Point site to host all transaction communication

• Multiple methods to reach employees

• E-mail blasts

• Topical newsletters (keep them short)

• Q&As posted weekly

• Periodic briefings, virtual and recorded

• Transaction calendar with progress updates

• Employee meetings scheduled with ESOP Trustee and other advisors, after disclosure materials are disseminated

S&ME’s Journey to a 100% S ESOP

Lessons Learned/Surprises Along the Way:

• Partner with an “A Team” to navigate this journey + transformation.

• Results drive a feverish employee-owned company. Winning culture.

• Employee-ownership culture takes time to build. Start early + often!

• Generational approach/outlook differs on employee ownership.

• Need constant reinforcement of employee ownership benefits… to employees!

• It’s all about People and Culture… employee ownership must be a differentiator, else other options exist.

Secret Word for CE

Questions?

Journey to a 100% S ESOP

Important Information

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.

2775189-032023

B. David Joffe, Bradley, Stephen A. Martin, Argent Trust, Matt Ryan, and S&ME, Inc. are not affiliated with any company of the Principal Financial Group®.

Reviewing ESOP Valuations: Best Practices for Trustees

and Plan Sponsors

Alex Perry, Managing Director

Ventura ESOP Fiduciary Services

Michael Lovett, Director

Acuity

Advisors

What is the role of the Trustee?

• Trustee is responsible for setting the stock price at least annually

• Trustee is held to Prudent Expert Standard

• Need to exercise prudence and care in retaining and overseeing appraisers' work

• Garbage in/garbage out: Need to ensure appraisers have access to appropriate and accurate information

• Doing your best is not sufficient. Internal Trustees are expected to be as prudent and have as much knowledge as external / professional trustees

Appraiser Qualifications

• # of annual Valuations, ESOP valuations

• Credentials of Appraisers (e.g. CFA, ASA, CPA/ABV, CVA)

• Involvement in ESOP community

• Litigation History

• Factors considered / Professional Standards compliance:

• Revenue Ruling 59-60

• Uniform Standards of Professional Appraisal Practice (USPAP)

• Statements on Standards for Valuation Services (SSVS)

What is the role of the Appraiser?

• Independent financial advisor to the Trustee

• Appraiser provides analysis and financial opinions to the Trustee to assist them in setting the stock value of the ESOP

• Use facts, data, analysis, and judgement to estimate the “Fair Market Value “ of the Company’s Securities

• Write a written report to document process and analysis to the Trustee

Typical Valuation Approaches

Income Approach

Common Methodologies

• Discounted Cash Flow (DCF)

• Capitalized Earnings

• Capitalized Cash Flow

Overview of Approach

• Based on the fundamental premise that value of the business is a function of the economic benefit it can generate

• Most methods based on capitalization of expected future economic benefit at an appropriate rate that captures the relative riskiness of the investment and the current economic environment

Market Approach

Common Methodologies

• Comparable Public Companies (GPC)

• Comparable Transactions (M&A)

• Prior Transactions in Company Stock

Overview of Approach

• Based on prices determined and tested by the marketplace

• Estimates the value of the business based on evidence of prices investors are willing to pay for companies in similar lines of businesses

Asset Approach

Common Methodologies

• Liquidation Value Analysis

• Adjusted Net Asset Value (ANAV)

Overview of Approach

• Based on the Company’s financial condition

• Focus on value of underlying assets (inventory, receivables, property & equipment, etc.) rather than cash flows generated by such assets

Trustee Review of Valuation

• Trustee should be involved throughout the process, not just after draft report is available

• Particularly important for internal trustees that aren’t directly responsible for appraiser diligence requests

• For internal trustees: Take minutes of discussion with appraiser to document process of share price approval

• Executive & Board should review valuation after trustee approval to understand value drivers

Sample Valuation Review Factors

• Look for year-over year changes in:

• Performance relative to budget (sales & EBITDA)

• Cumulative earnings of the forecast

• Increased/decreased risk premiums & valuation multiple

• Relative weightings of valuation approaches

• What is “moving the needle”?

• Ask for a change table if one is not provided

Income Approach Assumptions

Conclusions under the Income Approach are highly sensitive to the various assumptions used by the appraiser and input data. These assumptions should be examined to ensure they are reasonable.

Primary focus areas include:

• Projections

• Discount Rate

• Terminal Value

How to Examine Projections

• Examine the process used to create the projections and who was involved

• Top Down/Bottom Up

• Bias?

• Visibility on future?

• How does projected performance compare to historical? To industry/market? If different, what is driving the change?

• Is growth supported by projected reinvestment?

• Projections should consider both internal and external factors

Projections Review

• Need to understand the “why” behind deviations between historical and projected performance

Discount Rates

• The discount rate represents the required rate of return to compensate for the risk of an investment

• Higher – more risk, Lower – less risk

• Usually weighted average cost of capital (WACC) or cost of equity. The discount rate must match the type of cash flow projected

• Is affected by market and specific factors

• Market factors usually objective, company specific is more subjective

• Examine what is driving change

Terminal Value

• Terminal value represents value for cash flows beyond projected period. Not uncommon for the terminal value to represent a significant portion of the conclusion

• Gordon Growth Method or Exit Multiple – But should the method selected impact the conclusion?

• Gordon Growth is a mathematical simplification assuming a perpetual “steady state”. As such, the assumptions of the cash flow projection in this steady state are magnified.

• Consider business/economic cycles and historical performance

• Implied Exit Multiple <=> Implied Growth Rate

Market Approach Assumptions

At first glance, applications of the Market Approach may appear to have less assumptions to review.

Primary focus areas include:

• How comparable is the comp set? It’s ok to evaluate as a group.

• Why were the metrics used (revenue, EBITDA, historical, forward) selected? What adjustments were made, if any, to the selected metrics?

• Are the selected multiples supported by the comparable company data?

• How was the comparable data adjusted for to account for differences of the subject company?

Value Drivers – Controllable or Not?

• Interest rates, market multiples

• PPP, ERC impacts from 2020-2022

• One-time benefits may have assisted prior values even if not in Adj.

EBITDA

Other Valuation Considerations

Control and Marketability

Must consider appropriateness of adjustments to value for control and marketability or lack thereof

Repurchase Obligation

As the ESOP matures and stock value continues to increase, the put right propels repurchase obligation (“RO”)

Synthetic Equity

Granted to (1) incentivize and retain key management and/or (2) secure transaction financing

Process Agreements

DOL has entered into six agreements with certain ESOP trustees, addressing stock purchase or sale transactions

Reconciliation of Conclusions

• What approaches factored into the final value conclusion, and how were the various approaches weighted?

• If certain approaches were not used, why?

• For most ESOP companies, an Income and Market approach will be used. While there are always exceptions, if an Income or Market approach is not being used in your valuation, the trustee should know why.

• Does the conclusion “make sense”? Can you explain the reasons behind the change (or lack thereof) in the valuation?

Practical Advice for Trustees

What can internal trustees do to improve their process? Here are three suggestions that are easy to implement:

• Use a review checklist

• Request a “Change Table” or pricing bridge from the appraiser

• Identify and focus on the big hitters

• 80/20 rule: Usually, a few primary drivers can explain most of the change in value

• Don’t get bogged down on assumptions that don’t “move the needle”

Practical Advice for Trustees

Example of pricing bridge:

Session Takeaways

• Internal Trustees are expected to be as prudent and have as much knowledge as external / professional trustees.

• Documentation is key! Examinations from regulators often occur years later.

• If you don’t understand something in the appraisal, ask questions.

Conductor's Club Secret Word

The Colorado Employee Ownership Ecosystem

Sandy Shoemaker, Chair, Employee Ownership Commission

Doug Dell, Member, Employee Ownership Commission

Matthew Licina Program Manager, Colorado Employee Ownership Office

CE Requirements - Onsite

1. Scan the session QR Code on the door or directional signage nearby

2. Engage in the session content for all 60 minutes.

3. Input the secret word in the CE Session Survey. The secret word will be revealed in the speaker's presentation.

4. Complete the CE Survey.

• Introductions

• Why did Colorado place an emphasis on Employee Ownership?

• History of the Colorado Employee Ownership Ecosystem

• CY23 Employee Ownership Commission Strategic Plan

• Current Funding/Programming Opportunities

• Colorado Employee Ownership Case Studies

• Q&A

The Challenge

• 76% of small businesses in Colorado are owned by baby boomers (49,360 businesses)

• 6 out of 10 business owners plan to sell their business in the next decade

• 15% of businesses get passed down to the next generation

• Only 20% of all businesses listed actually sell

• Most business owners report having a hard time finding a buyer

Business Case for Employee Ownership

Research shows * that employee ownership firms fail at about 1/3 the rate of non - employee - owned firms in an economic downturn

USA:

•2.34 million businesses are owned by baby boomers

•With sales of $5.14 trillion

•Employ 24.7 million people

•With payroll of $949.1 billion

COLORADO:

• 50,750 businesses are owned by Baby Boomers

• With sales of $81.7 billion

• 419,700 jobs

• With payroll of $16.2 billion

* Source

Governor Polis issues

Executive Order (2019)

The Solution

Forming the Governor’s Commission on Employee Ownership to:

1. Identify & remove barriers

2. Educate businesses and community

3. Build robust Colorado-based technical support to assist in conversions

A Brief History of the Ecosystem

• August, 2019 , the Economic Development Commission (EDC) s eeds the program with $1.5M

• EO commission support; Hiring of EO program manager; Support of programming through OEDIT, RMEOC, CCWB and RMFU; Pilot grant program; Pilot loan program

• March, 2021, additional $750k added to the original EDC Seed Funds

• EO tax credit, Application for SSBCI (for EO use)

• April, 2022, additional r equest for SLFRF funds from the EDC for further activation of programming

• Activation of LMS content, EO tax credit expansion, SSBCI loan fund activation ($5M); Programming through RMEOC, CCWB, SBDC through 2026

The Employee Ownership Commission

Members: Jennifer Briggs, Doug Dell, Stephanie Gripne, Yessica Holguin, Chuong Le, Dan Luzietti, Kris

Oyler, Rep. Naquetta Ricks, and Jason Weiner.

1. Establishing a robust and wide-reaching network of technical support for businesses wishing to convert to employee ownership;

2. Educating businesses and communities across the State on the economic and community benefits of employee-owned businesses; and

3. Identifying barriers to the development and advancement of employee owned businesses and recommending State actions and resources to remove such barriers.

Sandy Shoemaker Chair Kerry Siggins Vice Chair

EO Commission – Structure

Governor appointed.

Terms of 1-3 years with option to extend.

Vice Chair election in January, Vice Chair moved to Chair after 1 year.

Active working commission, serves as model to other groups.

EO Commission – Structure

Comprised of EO business leaders, service and technical assistance providers (e.g., attorneys, bankers, CPA’s, developers, etc.), and a legislator.

Advise on legislative needs, iterations to address barriers/ hurdles in funding, due diligence in funding applications, development and deployment of educational programming, marketing and outreach, etc.

Monthly meetings, open to the public, featuring presentation, and partner and office updates.

Work directly with Program Manager at OEDIT.

EO Commission – Strategic Aims

• Focus on sectors and geographies to identify and develop EO opportunities

• Connect with established professional organizations that touch business owners, form partnerships

• Educational Programming - marketing and content development

• Increase usage and awareness of financing sources

• Expand use of statewide support for conversions

• Provide opportunities for EO companies to connect

Partner Organizations

The mission of the ROCKY MOUNTAIN EMPLOYEE OWNERSHIP CENTER (RMEOC) is to build a more just and sustainable economy through employee ownership.

The vision of the CENTER FOR COMMUNITY WEALTH BUILDING (CCWB) is a people-owned, inclusive, and sustainable Metro Denver economy that catalyzes prosperous and resilient communities free from racism and injustice.

Key Metrics and Milestones

• 57 Conversions to EO structures

• 1,700+ Employee Owners created

• Activation of $3k Grant Program

• 2 cycles/year

• Activation of Technical Assistance

• Via EO Office & Ecosystem Partners

• Production of Own It: A Colorado Story Documentary

• Outreach to 10k+ Businesses

• EO Tax Credit , $50M over 5 years

• 11 in queue

• Activation of 3 Peer Networks

• ESOP Executives

• ESOP Communications Committees

• Worker-Cooperative

• Activation of Colorado - based Service Provider Network

• Legislative approval to broaden EO Loan Program

• Activation with SSBCI

• National recognition of Colorado’s leadership on EO

• TEA Torchlight Award to Gov Polis

• SBA Administrator Visit

Tax Credit Passes 6/23/21!

(I) THE PURPOSE OF THIS SECTION IS TO PROVIDE AN INCENTIVE FOR SMALL BUSINESSES TO ESTABLISH EMPLOYEE STOCK OWNERSHIP PLANS OR EMPLOYEE OWNERSHIP TRUSTS , OR TO CONVERT TO A WORKEROWNED COOPERATIVE ;

Tax Credit Program Announcement

First Issuance – Topnotch Log Works 1/31/23

Tax Credit Usage

Tax Credit – Now Let’s Expand It!

• Increases cap from:

– $25,000 → $40,000 for: EOT, Co-op

– $100,000 → $150,000 for: ESOP

• Addition of 8 eligible structures

– “alternative equity structures”; $25,000 each

• EO M&A’s eligible

• Any 20% equity transfer to employees is eligible

Colorado Employee Ownership Office Programming

● No-cost consulting

● Service Provider Referral Network

● Peer Network Groups for employee-owned companies

● ���� Employee Ownership Grant Program

● $3,000 reimbursement grant to offset conversion costs

● Exit Planning Institute Owner Readiness Survey

● ���� Employee Ownership Tax Credits (opened 01/2022)

• 50% off conversion costs to selling owner(s), not to exceed:

• $25,000 - EOT and Co-op

• $100,000 – ESOP

Usage of Employee Ownership Grant

Peer Network Programming

Peer Network Programming

State of Owner Readiness Report Event

Colorado Employee Ownership Office Programming

● Introduction to Employee Ownership on-demand course (Launched 2/23)

● ���� SSBCI levels for Cash Collateral Support (CCS) and Colorado Credit Reserve (CCR) were increased:

● Can be used together for EO transitions

● CCS: Credit enhancement for EO businesses and lenders, up to 25% of the loan amount or $250k, whichever is less

● CCR: Helps lenders make loans by establishing a loan loss reserve account with the lender as additional security on loans (up to $500k)

● Exit Planning Programming on-demand (Launches Fall 2023)

“Introduction to EO” Learning Course

“Introduction to EO” Learning Course

State of Owner Readiness

Exit and Succession Planning

• Objective: Mitigate impact to Colorado’s local and broader economies from boomer- owned businesses potentially closing

• Programming will provide the opportunity to broaden and scale the Employee Ownership Office’s programs.

• Launching in Fall 2023

• Targeted towards business owners

• To be deployed via Small Business Development Center Network

• 1-3 Consulting sessions with Certified Exit Planning Associate

Case Study – New Wave Environmental

• Founded in 1993 by Lee and Sheri Archer to develop, patent and trademark a top-of-the line family of water filters, NWE is now selling 5 products lines of filters and reusable water bottles/containers.

• The Colorado company’s products eliminate waste through reusability, preventing 200M+ single-use trash-ready bottles from entering landfills. Products are sold in all 50 states through national retail account relationships.

• Competitive advantage is a focus on sustainability, knowledge, quality and customer service.

Case Study – New Wave Environmental

• Founders sold their shares to an ESOP trust on 1/1/2023 with the desire to provide a broad-based retirement benefit to company employees.

• Colorado’s Employee Ownership Tax Credit was an important consideration: Professional Fees were estimated at $160,000.

• 50% of Fees will be reimbursed through EOTC.

Case Study – Fancy Tiger Crafts

• Business established in 2008 by 2 owners with the intention of making a wide variety of craft supplies and skills available to their community. • 2 owners ready to take more time for themselves, not looking to abandon business.

Case Study – Fancy Tiger Crafts

• With support from RMEOC, law firms: Jason Wiener pc and Pote Law, and CO EO Office, 2 owners sell to employees.

• Legacy is preserved!

• Owners were fond of inherent equity in co-op structure.

• “They all put in the same risk and no one is taking on more risk than anyone else”

Case Study – Peak Food and Beverage

• LLC established in Durango, CO, in 1994, and has grown to include 5 locations

• Kris Oyler had 3% profits interest at start

• Established Peak LLC to hold interests

• Currently 40% employee-owned; 70% locally-owned; 45+ employee-owners

• EO structure is full membership in the LLC including equity, profits interest and voting rights

Secret Word for CE

McFadden's

NCEO Resource Guide

Questions and Comments

The Colorado Employee Ownership Ecosystem

Sandy Shoemaker, Chair, Employee Ownership Commission

Doug Dell, Member, Employee Ownership Commission

Matthew Licina Program Manager, Colorado Employee Ownership Office