Unique Structuring Issues with ESOPs Presented by Neal Hawkins Marilyn Marchetti Grant McCorkhill Art Miller Verit Advisors First Bankers Trust Holland & Knight Holden Industries
Discussion Topics For Today Structuring Issues for New ESOPs Partial-to-Full ESOP Transactions ESOPs as an Acquisition Vehicle Use of LLCs within ESOP Companies
Structuring Issues with New ESOPs
Redemption vs Sale Cash Company Lender(s) Debt Sellers Stock Sale Promissory Note ESOP TRUST/ Employee Benefit Plan
Full Redemption Full Redemption Followed by a Sale of Stock to the ESOP Legal or Trustee thoughts? Right Size the ESOP loan Seller Note collateral with the operating entity Can t elect 1042
Full Sale of Stock to the ESOP Sale of all Stock to the ESOP Legal or Trustee thoughts? Can t Right Size the ESOP loan Seller Note is with the non-operating entity Can elect 1042
Partial Redemption, Partial Sale Sale of some stock to the ESOP Trust and then a redemption of the remaining stock Legal or Trustee thoughts? Can Right Size the ESOP loan Seller Note is most likely with the operating entity Can elect 1042, but could be limited
Cash Flow and Financing Implications Understanding the cash flow implications of going to a 100% ESOP How is the transaction going to be financed? Senior Debt Junior Capital Seller Notes 401k raise Cash at close and cash flow over 10 years
Case Study - Transaction Value - $100mm No Seller Financing all cash at closing Financing provided by combination of senior debt and junior lien debt Equity provided by voluntary employee rollover of qualified retirement plan funds
Simultaneous Sale and Redemption Company Lender(s) Sellers ESOP TRUST/ Employee Benefit Plan Employee 401k & P/S
Issues in 401k Raise Transactions Leveraged vs. unleveraged ESOP Unusual terms in ESOP relating to distribution, diversification, hardship, etc. Securities law and other issues relating to equity raise -- disclosure document Ownership culture issues and education
Partial to Full Transactions
Redemption in a Partial ESOP Advantages No post transaction stock price decline Simpler transaction ESOP is not buying stock Might not have an additional/new inside loan *** Considerations Might exacerbate a have and have-not problem No new stock to the ESOP Can not elect 1042 treatment
Sale of stock to the ESOP Advantages New shares to the ESOP Can re-right size the ESOP Able to elect 1042 treatment Considerations Post transaction drop in value Will price protection be needed New inside loan or renegotiate the existing inside loan
Partial Redemption and Partial Sale Advantages New shares to the ESOP Can re-right size the ESOP Able to elect a portion of the sale as 1042 treatment Considerations Post transaction drop in value Will price protection be needed New inside loan or renegotiate the existing inside loan
Case Study - Transaction value of $750mm for 67% equity stake to go to 100% ESOP ownership Selling Shareholders wanted to take advantage of 1042 for a portion on their sale for charitable donation Renegotiated and combined the ESOP internal loans into one loan Price protection for existing ESOP participants who retire
Simultaneous Sale and Redemption Cash Company $400 MM Debt Lender(s) Sellers Stock Sale Promissory Note ESOP TRUST/ Employee Benefit Plan
ESOP as an Acquisition Vehicle
S-Corp Tax Benefits Increased cash flow means acquirer can qualify for larger financing Cash flow of Target is more valuable to Acquirer than Target 1042 Election to the Target Shareholders Tax Deduction for Purchase Price Payments
Employee Benefits Employees of the Target can be included in the ESOP plan May allow acquirer to negotiate favorable employment terms due to this new benefit Create a new pool of unallocated shares avoid a have and have-not problem
Case Study S Corp Acquisition Acquirer is a 100% ESOP owned S-Corp Target is any type of corporation or entity with the shareholders being individuals, Trusts or other entities
Simultaneous Sale and Redemption Target Acquirer ESOP 2 Acquirer S-Corporation Cash 1 Note Lender
ESOP the Acquirer Advantages Stock or Asset Purchase no step up in basis Increased cash flow for debt service Tax free combined entity Considerations If stock purchase target must become a qualified subchapter S-Corporation subsidiary Taxable to the seller Allocation of shares to a larger pool of participants
Case Study 1042 Election Acquirer is a 100% ESOP owned S-Corp Target is a C-Corp to qualify for tax deferral or an S-Corp that can convert into a C-Corp Selling shareholders can be individuals, Trusts or other entities, but can not be C- Corporations
Phase 1 Target ESOP 100% Target S/Hs Target
Phase 2 Acquirer ESOP 100% Target ESOP 100% Acquirer Target (Step 1) Acq sub is formed Acquisition Subsidiary
Result Acquirer ESOP Acquirer (S Corp) Target (QSUB)
ESOP the Acquirer with 1042 Advantages 1042 deferral for the selling shareholders Increased cash flow for debt service Tax free combined entity Considerations C-Corporation ESOP can only purchase the stock
Use of LLCs within ESOP Companies
How LLCs can be Used with ESOPs Used to bring capital into the ESOP entity equity or debt Leased employee structure Professional organizations where only a subset of the employees can be part of the ESOP Situations when there is more than 100 shareholder
Case Study Founding Family wanted to cash out, elect 1042 deferral and have the company remain private Retain relationship with its supplier, a co-op, who was also going to be a source of financing Allow shareholders and others key individuals to buy into the new company ESOP to be the sole shareholder for tax exemption
Case Study Continued Company was able to secure $65MM in bank financing and $8MM in seller notes Subordinated loan of $9.5MM from supplier with an equity interest LLC was used to retain all the assets and liabilities. The operating entity (ESOP) with a 75% ownership with the remaining 25% ownership to the subordinated lender in exchange for the $9.5MM
Phase 1 Shareholders Shares $63 MM ESOP Shareholder Seller Note $8 MM Operating Co $75 MM Lenders
Phase 2 Operating Co Lenders $32 MM All assets and liabilities 75% ownership $9.5 MM equity investment 25% ownership Existing Lenders LLC
Questions